Valero (NYSE:VLO) and Tesoro (NYSE:TSO) have fallen by 7% and 6%, respectively, in the last two days. This decrease was witnessed after another refinery, Chevron (NYSE:CVX), decreased its third quarter future guidance and few stock specific news that we have discussed below. In our opinion, both Tesoro and Valero are trading at cheap valuations and have significant potential to sustain high profits in the coming period.
Tesoro's share fell by approximately 6% to $38.5 in the last two days, with a trading volume of 10 million shares. Investors showed concerns regarding the criticism by activists of the purchase of Arco Retail and BP's Carson refinery. Activists believe that these deals will raise fuel prices through a reduction in competition. They are appealing to the federal regulators to stop the deal. Furthermore, they believe California's gasoline prices are increasing sharply because 51% capacity of the California refinery is in the hands of Tesoro and Chevron. Consumer groups want more competition in the market and requested the state department to look into the matter.
In order to cope with the situation, Tesoro is planning to sell its 97,000 bbl/day Wilmington refinery and buy BP's 260,000 bbl/day Carson refinery. In this way, it would save itself from the government's stringent regulations, double its market share, and have the highest crude refining capacity of 25%, according to the data gathered by Bloomberg. Moreover, the company's strong figures make it confident of bagging the deal.
In our opinion, Tesoro has strong potential to overcome the concerns raised by the consumer groups. Gasoline prices are increasing because of refinery and pipeline outages, and because oil and gas companies do not have any control on events like Hurricane Issac. Other important reasons behind the sharp increase in gasoline prices are the fire breakdown in Chevron's Richmond refinery and the shutdown of Exxon Mobil's (NYSE:XOM) California refinery due to power outages. Therefore, as a matter of fact, the Tesoro's purchase of the BP refinery has nothing to do with these unexpected events, which are the main reasons behind the rise in gasoline prices. We believe Tesoro will complete the purchase of BP's Carson refinery and its supply chain network, along with buying 800 retail stations in the Southwest. It would enhance its market share and the refining capacity to a great extent.
We believe TSO is attractive to the value investors because of high crack spreads, enhancement in throughput in the California region and growing capacity utilization. It is trading at a price to sales of 0.17x, at discount when compared to the industry average of 0.39x.
Valero shares also registered a downside of 7% in the last two days and closed at $29.4, with a trading volume of 31 million shares. The negative sentiment of investors is primarily because of Chevron decreasing its third quarter profitability guidance. Moreover, the recent insider selling has disconcerted investors. Its Director Marbut Bob has sold 750 shares worth $23,675. Another concern for investors is the negative sentiment of consumers regarding rising gasoline prices in California.
In our opinion, this negative sentiment will prevail for a short period of time, and the stock will again become attractive to investors due to high growth prospects, low valuations and good dividend yield. The company will benefit from hydro-cracker projects and increasing exports. Its Port Arthur and St. Charles projects are expected to be completed in the next few quarters, and would bring significant amount of growth to the company. The stock has a dividend yield of 2.4%, higher than the industry average of 1.46%. The stock is attractive to investors due to its cheap valuations. It is trading at 0.1x to its sales, at a considerable discount when compared to the industry average of 0.4x.
Therefore, investors looking for capital appreciation and exposure in the refinery business should take long positions in Tesoro and Valero.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by Qineqt's Energy Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.