Alon USA Energy Inc. (NYSE:ALJ) is a small/micro cap refiner. It also sells gasoline at retail outlets -- often with convenience stores. There is nothing sexy about it. There is nothing HFT/momentum traders can fool investors with for very long. It is just a simple refiner that has only just begun to recover from the last recession. This company has more debt ($876.42 million) than its market cap ($787.14 million). That's the mark of a troubled company. It does have a Price/Book of 2.21; but given the distressed prices refineries have sold for in recent years, the book value may be far overstated. It trades at a P/E of 30.43. This is far beyond the P/Es of other, more successful refiners. The purported reason for this would be its average analysts' five year EPS growth estimate per annum of 26.20%. However, Alon has missed earnings estimates for three consecutive quarters -- badly. There is no reason to have faith in this five year estimate. In fact Alon has historically disappointed, so betting against that estimate would historically be a good bet.
The US economy has slowed from GDP growth of 2.0% in Q1 of 2012 to GDP growth of 1.5% in Q2 of 2012. Some people think it will ramp back up in Q3 and Q4, but others are not so sure. Many businesses are worried about the effect of the fiscal cliff and tax-maggedon. They may be conservative in both CapEx spending and in hiring.
The fiscal cliff refers to the automatic federal budget cuts that are scheduled for the end of this year unless Congress acts to change this. These are substantial ($1.2T). These budget cuts would put many people out of work. Those people's lack of work generated money to spend would then put still further people out of work.
Tax-maggedon -- the expiration of the Bush era tax cuts -- would take still more money away from US citizens. If they spent less (because they had less to spend), that would put still more people out of work. All this means that people will be conserving more than they have been in the past. They will be buying less gasoline (and other refined products). When they buy less gasoline they will also be visiting the convenience stores at Alon's gas stations less frequently. Those too will sell less. In sum Alon will have a much harder time making money. Some stores/stations may even close.
Many insist that this situation will all get kicked down the road, especially if Romney gets elected. However, it will have to be dealt with at some point. The US budget deficit has increased from roughly $10.5T to $15.5T so far under Obama (an increase of about $5T). The US cannot keep deficit spending at the rate it has been. Other countries will not want to buy our bonds or invest in the US. If that happened (and it already is to some extent), it could cause a US depression. The can kicking is close to over. You can count on tightening your belt next year and for the few years after that. The PIIGS situations are not a joke. They are a demonstration of what can happen to a developed economy that shrugs off responsible budgeting. The US has shrugged off responsibility far too long with dire results, and its future budget problems look disastrously more serious with the current projections for Medicare and Medicaid expenses as the Baby Boom generation retires. Can kicking cannot be allowed much longer if the US does not want to become another Greece.
The CBO (Congressional Budget Office) has predicted a -1.3% GDP growth recession for the first half of 2013, if the US goes over the fiscal cliff. The CBO is notoriously overly optimistic. Even if we do not go over the fiscal cliff, there will be a downturn in the economy as a penalty for coming close; and Congress will ensure that we at least come close. You should get your suspenders out because your belt may not tighten enough.
This means that cyclical companies such as refiners will get hit hard. It means the crack spread will contract as people try harder to get as much gasoline for as little money as possible. The crack spread will tighten further as US drivers try to cut down on any unnecessary driving. Already we have seen signs of this happening, and we are not even close to the penultimate day before the fiscal cliff and tax-maggedon hit. The chart below shows the one year 321 crack spread.
As you can see from the chart, there was a spike downward of more than $10 per barrel in mid to late July. The crack spread has recovered some of that to stand at $23.29600 as of this writing. However, this may only be at a secondary peak in the downward trend. Curiously, analysts raised their earnings forecasts for Alon after this point (from $0.51 to $0.75 per share for Q3 2012). I presume they were not watching the crack spread chart, but instead they heard ALJ say that it had increased its refineries' throughput by 19% year over year (at the Q2 earnings release). The crack spread on average for Q3 2012 should be much lower than the crack spread in Q3 2011.This means the analysts have ensured another big miss by ALJ for Q3 2012. Ultimately this means that the current PE will worsen after the Q3 results. When growth stocks disappoint, their stocks usually fall dramatically.
Simple truths often work well in the stock market, especially with cyclical stocks. The simple truth is that the summer driving season is almost over. Kids are going back to school. Typically, the crack spread will fall at this time as the summer driving season is often its high point. There is no reason to expect that it will not. We are not about to enter an economic boom. This likely means that the crack spread is heading significantly lower.
ALJ was not profitable in Q4 2011, when the crack spread was below $20 per barrel. The crack spread is likely headed back in that direction. It is time to take profits in ALJ stock if you own it. If you are an aggressive trader, you may wish to short ALJ.
The five year chart of ALJ shows how ALJ reacted to the last recession.
The slow stochastic sub chart shows that ALJ is overbought. The main chart shows that ALJ is far above its 200-day and 50-day SMA's (likely to fall back toward them soon). The overall market is also overbought. ALJ with a Beta of 1.6 would outperform the market to the downside, if the market and ALJ were to correct from their overbought states. David Kostin, Chief Forecaster for Goldman Sachs, has a 1250 price target on the S&P 500 for the end of 2012. The current futures value of the S&P 500 is 1406.80. That's an 11%+ fall, and there is no saying the S&P 500 will stop at 1250. Nomura Securities is calling for a 25% drop. If you multiply these predicted drops by ALJ's Beta of 1.6, you get a roughly an 18% to 40% drop by the end of the year.
Of course, some people are saying that the Fed will come in with QE3. This will then float all boats. The problem is that this will not really work for ALJ or other refiners. If the Fed says it will do a huge amount more QE, this will mean the economy is in bad shape. This will not make people want to spend. Instead they may well tighten their belts. Further QE usually makes the price of oil go up significantly (perhaps $20 per barrel or more). You are printing money after all, and oil is a hedge against inflation. The extra $20 per barrel would most likely pressure the crack spread downward. People would still be tightening their belts. The price of gasoline would resist going up, but the price of oil would spike up quickly. If the US later went into recession, the crack spread would fall further, as it usually does during hard times. The refiners are not in a good place at the moment. Recognize that, and act accordingly.
Parts of this article are specific to ALJ, but much of it is generally applicable to US refiners. A few of the other currently overbought US refiners are: Valero Energy Corp. (NYSE:VLO), Delek US Holdings (NYSE:DK), and Tesoro Corp. (NYSE:TSO). Western Refining (NYSE:WNR) is not as overbought, but it is still very susceptible to a strong pullback with its Beta of 1.82.
Note: Some of the fundamental fiscal data above is from Yahoo Finance.
Good Luck Trading.