The Best Ways To Play The Refinery Comeback

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Includes: CLMT, HFC, TSO
by: Justin Kuepper

Oil refinery stocks may not be the most interesting companies in the world, but they are starting to catch the attention of investors. In particular, Warren Buffett and Carl Icahn have both snapped up shares in major refinery stocks as cheaper crude oil, increasing exports and more shareholder friendly actions have driven better than expected second quarter earnings.

For example, Calumet Specialty Products Partners LP (NASDAQ:CLMT) recently reported record quarterly adjusted EBITDA of $122.3 million as it swung to a net profit of $65.7 million last quarter, with analysts projecting double-digit growth over the next five years. Meanwhile, Exxon Mobil (NYSE:XOM) reported just single-digit increases in sales last quarter with similarly lackluster projections.

The Best Income Play

The oil and gas production and exploration sector is perhaps best known for its steady dividend payouts due to its steady income streams. In the past, refiners didn't share this similarity and were more known for their reinvestment in additional capacity. But with the economy remaining slow, many refiners are shifting their focus to buybacks and dividends.

Calumet Specialty Products is one of these refiners with a changing mindset. Even though it already pays a hefty 9.3% dividend yield, the company raised its payout by 5.4% quarter-over-quarter and 19.2% year-over-year last quarter to $0.59 per share. And, with a price-earnings (P/E) multiple of just over 8x its trailing 12-month earnings, it's hardly overvalued right now.

Two Strong Runners Up

While Calumet Specialty Products may have the highest yield in the space, Tesoro Corporation (NYSE:TSO) and HollyFrontier Corp (NYSE:HFC) also offer dividend payouts of over 1.4% and a similar growth story. HollyFrontier trades with a P/E multiple of just 5.4x, while trades at just 7.6x its trailing 12-month earnings, despite its significant growth over the past few quarters.

These companies have benefited from the vast expansion of shale oil. For instance, HollyFrontier owns many refineries that are close to many new oil wells, which helped it earn seven times more revenue than it did just a year ago. And with the ongoing expansion in the U.S., it's not hard to imagine these trends continuing over the next couple of years.

Potential Downside Risks

Despite the upside potential, there are some risks that investors should be aware of before investing in these companies. On the upside, too much success could lead to more larger companies re-entering the refining business and driving down prices. On the downside, additional declines in gasoline demand could eventually catch up with refiners.

To hedge against these risks, investors may want to consider using some common options strategies. For instance, covered call positions enable investors to realize an extra "dividend" that can help offset any declines. The only drawback of these positions is that the investor may end up selling too early and leaving profits on the table.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.