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The decline in the price of oil and gas at the well has not been good for the exploration companies nor have consumers seen any benefit. However, the refiners are reaping the benefits of lower raw material costs. Two refiners that stand out are Delek US Holdings (DK) and Western Refining (WNR). Both companies have done very well over the past year with Delek's share price appreciating about 69% and Western Refining appreciating about 53.5%. I think both companies continue to be undervalued and offer good upside potential.

Delek US Holdings

From the company's website:

"Delek US Holdings, Inc. is a diversified downstream energy company focused on petroleum refining, the wholesale distribution of refined products and convenience store retailing. The refining segment consists of refineries operated in Tyler, Texas and El Dorado, Arkansas with a combined nameplate production capacity of 140,000 barrels per day. The marketing and supply segment markets refined products through a series of owned and third-party product terminals and pipelines. The retail segment supplies fuels and merchandise through a network of approximately 374 company-operated convenience store locations operated under the MAPCO Express®, MAPCO Mart®, East Coast®, Fast Food and Fuel™, Favorite Markets®, Delta Express® and Discount Food Mart™ brand names."


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Revenues

In 2Q12, Delek reported sales of $2,134.2 million as compared to $1,848.7 million in 2Q11 for a 15.4% increase. For the twelve month period, sales totaled $8,510.6 million or 75.2% more than the year ago period. Total sales in FY11 were $7,198.2 million.

Sales for the refining segment increased to $133.2 million in 2Q12 compared to $122.3 million in 2Q11. The results reflect inclusion of the El Dorado refinery and increased asphalt prices. The Tyler facility saw a drop in production from 60,034 barrels per day to 56,729 barrels per day during the quarter. This is attributed to a temporary disruption due to a power outage. The El Dorado facility saw throughput at 70,368 barrels per day.

In the retail segment, sales increased to $18.2 million from $14.6 million. The increase can from higher same store sales volumes. The marketing segment saw sales in the quarter increase to $7.5 million from $5.1 million.

Earnings

EPS in 2Q12 rose to $1.15 versus $1.08 in 2Q11. The trailing twelve months saw EPS at $3.42 as compared to a loss of $0.09 in the year ago quarter.

Analysts forecast 3Q12 EPS in the range of $1.35 to $1.66. The consensus is for $1.54. For the fiscal year ending in December, analysts estimate EPS in the range of $3.97 to $5.50 with an average estimate of $4.53.

The company will hold its third quarter conference call on November 8th.

Margins

Gross margin slipped to 10.5% for the trailing twelve months from 10.7% in F11. However, the gross margin remains above the five year average of 10.04%.

Operating margins improved to 4.3% from 4.2% and are well above the five year average of 1.9%.

Net margin also improved. It stands at 2.4% compared to 2.2% for F11 and above the five year average of 0.62%.

Balance Sheet

Delek reported cash and short term investments of $321.1 million as of 2Q12. At the end of F11, the company reported $225.9 million. Long term debt is $310.9 million, down by $47.5 million. The company reported they repaid $38.5 million owed to the Delek Group.

The current ratio is 1.1X which is better than the industry median of 0.9X. The long term debt to capital ratio is 29.1% and the long term debt to equity ratio is 41.1%. Times interest earned is 6.9X. With free cash exceeding long term debt, I think Delek is well capitalized.

Inventory to sales dropped to 0.043 from FY11 when it was 0.071. In FY10, the inventory to sales ratio was 0.036.

Book value per share is $13.00 and tangible book is $11.54.

Capital Allocation

The company pays an indicated dividend of $0.15 per share yielding 0.6%. The company has also declared a special cash dividend of $0.10 payable October 30th. The company has been issuing new shares which are dilutive.

Profitability

Delek has a return on equity of 29.1% compared to an industry median of 6.6% and return on invested capital of 34.47% versus the industry median of 2.6%. The cash return on invested capital for Delek is 29.95% while the industry median is 9.54%. By these metrics, Delek is a very profitable company.

Valuation

Valuation is where the rubber hits the road. On a PE basis, Delek is undervalued. The trailing PE is 7.4X, the PEG is 0.9X and the forward PE is just 5.5X. The industry median PE is 12.6X. If we apply the industry median PE to next year's estimated EPS, the implied value is $41.20.

The current price to book ratio is 1.93X which is a premium to the industry median of 1.4X. Delek's price to book is also higher than its five year average of 1.27X.

The price to sales ratio is extraordinarily low, at 0.17X when the industry median is 2.29X. However, it is consistent with the company's five year average of 0.16X.

Enterprise value to EBITDA is a commonly used metric. Delek has a current EV/EBITDA ratio of 3.96X, low when compared to the industry median of 7.45. The five year average is 16.8X.

Delek U.S. holdings appears to be a deep value play. The company is trading about 9% off its 52 week high.

Western Refining

Western Refining, Inc. is an independent refining and marketing company headquartered in El Paso, Texas. Western operates refineries in El Paso, and Gallup, New Mexico. Western's asset portfolio also includes standalone refined products terminals in Albuquerque and Bloomfield, New Mexico; asphalt terminals in Phoenix and Tucson, Arizona, Albuquerque, and El Paso; retail service stations and convenience stores in Arizona, Colorado, New Mexico and Texas; a fleet of crude oil and finished product truck transports; and wholesale petroleum products operations in Arizona, California, Colorado, Maryland, Nevada, New Mexico, Texas, and Virginia.


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Revenues

In the second quarter of F12, Western Refining reported a decline in sales to $2,469.3 million from $2,557.9 million in the year ago quarter. For the year ending December 2012, analysts estimate revenues in the $7,751.5 to $13,198.2 range with an average estimate of $9,883.52. Sales in F11 were $9,071.0 and for the trailing twelve months, $9,482.1.

Earnings

WNR reported 2Q12 EPS of $2.19 compared to $0.94 for 2Q11. Trailing EPS is $1.37 diluted compared to $1.34 for FY11. Analysts estimate FY12 EPS in the $3.53 to $5.60 range. The estimates average $4.91.

Margins

Western has a current gross margin of 12.1%, the highest it has been in recent years and well above its 6.76% five year average.

The operating margin expanded to 4.6% from FY11's margin of 3.9%. The five year average operating margin is 1.73%.

The net margin also improved. Currently, it is 3.2% as compared to 1.4% in December 2011.

Balance Sheet

Western Refining has $346.1 million in cash and short term investments and $498.5 million in long term debt.

Inventory to sales is currently 0.04% compared to 0.03% in December 2011 and 0.05% in FY10.

Times interest earned is 2.6X. Long term debt to free cash is 83.8%. This implies that WNR could pay off its long term debt from free cash within one year. Long term debt to capital is 33.1% and long term debt to equity is 49.6%.

Capital Allocation

Western has an indicated dividend of $0.32 per share providing a current yield of 1.3%. The next dividend payment date is 11/09/12. The company has been diluting shares. The company currently has 90.02 shares outstanding compared to 88.98 million shares in December 2011 and 68.4071 million in December 2005.

Profitability

We are measuring profitability using return on equity and return on invested capital. ROE is 35.2% and ROIC is 45.4%. Cash return on invested capital is 39.57%. All three measures are very strong when compared to the respective industry median.

Valuation

The company has a trailing PE of 18.6X and a forward PE of 5.2X. The industry median PE is 12.6X. If we apply the industry median PE to WNR's estimated FY13 EPS, we get an implied value of $51.28.

Looking at price to book, the company is priced at 2.2X book. The company's five year average PB ratio is 1.83 which implies the company sells at a premium.

The price sales ratio of 0.24X is above the five year average of 0.17X. The industry median PSR is 2.3X.

The enterprise value to EBITDA ratio is 5.77X which is below that of the industry median of 7.45X. Enterprise value to sales, at 0.24X is well below the industry median of 4.63X.

Conclusion

Both companies appear to me to be deep value opportunities that are benefiting from the abundance of oil and the high prices consumers are paying for these products. This disparity may not last long.

Source: 2 Deep Value Oil Refiners