5 Pipeline And Refining Companies Gushing Free Cash Flow

Includes: CLMT, HFC, KMI, MPC, PSX
by: Richard Evans

The past two months I have been highlighting how the energy industry has changed. Gone are the days when the energy producing stocks were high wire acts while pipeline companies and refiners were poor relations. Midstream and downstream companies were considered slow performers shackled with heavy capital expenditure and paper thin margins.

As I wrote about in this article, rapidly expanding oil production in the United States mid-continental areas, combined with ever tightening refining and pipeline capacity, has drastically skewed normal energy economics. Wide spreads between U.S. interior crude and world finished products mean pipeline and refining companies are now cash flow juggernauts. It supports expanding share price and advancing dividends for the group, all good things for investors.

I looked at a random basket of these stocks to see how they are doing individually now, as well as what their prospects look like going forward. These are Calumet Specialty Products Partners LP (NASDAQ:CLMT), Holly Frontier Corporation (NYSE:HFC), Kinder Morgan, Inc. (NYSE:KMI), Marathon Petroleum Corporation (NYSE:MPC) and Phillips 66 (NYSE:PSX). For the sake of disclosure I currently own Holly Frontier and Phillips 66 in my portfolio.

Calumet Specialty Products Partners LP

Calumet specializes in refining its crude oil, feedstock in refining parlance, into specialized products such as lubricating oils, waxes, and solvents. It also refines its feedstock into fuel products such as gasoline, diesel and jet fuel.

The company's recent closing price was $31.63, within a 52-week trading range of $18 - $33.96. Calumet currently trades at a Price to Earnings ratio of 9.6 with earnings per share of $3.30. The company has a strong cash position as reflected in its comfortable current ratio of 2.54. It has profit margin 0f 4.05% and operating margin of 3.76%.

CLMT Chart
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CLMT data by YCharts

Calumet just raised its quarterly dividend to $0.62, payable November 14 to shareholders of record 2 November. The annual yield on the dividend is an eye-popping 7.84%, with a payout ratio of 67.6%, which is higher than truly comfortable.

The company is an aggressive acquirer and it is currently buying a small refinery in Montana for about $120 million, which is expected to improve Calumet's refining capacity by a further 9,800 bbl/d. Calumet is also expanding and upgrading other refineries to make itself more flexible.

This is one of my favorite parts to Calumet. There are over 300 grades of crude oil, all needing different refining processes to maximize the valuable products at the end output. The more upgraded the refinery the more productive it is, and more flexible in the types of feed stock it can handle. It allows the company to buy from a wider range of feedstock to get the best cost deal.

I like Calumet's position, although I am a touch worried about its cash position. This has high upside but a bit more risk than other companies on this screen.

Holly Frontier Corporation

In contrast Holly Frontier concentrates on producing high value light products such as gasoline, diesel fuel, jet fuel and other specialty products. Its refineries are located in Kansas, Oklahoma, New Mexico, Wyoming and Utah, which is ground zero for taking advantage of the best crack spreads right now.

Holly Frontier's recent closing price was $37.72, within a 52-week trading range of $21.13 - $42.33. The regular dividend is $0.20 quarterly, for a yield of 2.12% and with a payout ratio of 36%. However management is a serial special dividend distributor, having fired off $2.50 in special cash distributions to shareholders just in the last 12 months. This pushes the real dividend annual yield to 7.5%,

HFC Chart
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HFC data by YCharts

The shares as currently traded are new. The company formed as a merger of the old Holly Corporation and Frontier Oil. Holly Frontier currently trades at a Price to Earnings ratio (NYSE:PE) of 5.3 with earnings per share of $ 7.09. The company has a current ratio of 2.37, a profit margin of 7.45% and operating margin of 12.58%.

Not only does this independent refiner use its free cash flow to push out lots of dividends for its shareholders, it also has a hefty $350 million share buyback program. It is a management truly dedicated to bringing value to shareholders and I absolutely adore that.

I consider Holly Frontier an excellent investment for small and mid-cap dividend investors.

Kinder Morgan, Inc.

Kinder Morgan is an energy storage and pipeline transportation company, operating in North America. KMI Products Pipelines section distributes diesel fuel, gasoline, and jet fuel and natural gas liquids and also holds 60 associated product terminals and petroleum pipeline trans mix processing facilities.

The company's recent closing price was $34.11, within a 52-week trading range of $ 26.91- $40.25. KMI currently trades at a Price to Earnings ratio (PE) of 28.6 with earnings per share of $1.19. It pays a quarterly cash dividend of $0.36 per share ($1.44 annualized) for an annual yield on the dividend at 4.22%.

KMI Chart
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KMI data by YCharts

The current Return on Assets is down, and Kinder Morgan has a current ratio of 0.7 - worrying that the low number shows the potential for future liquidity problems. It has profit margin 0f 2.74% and operating margin of 24.36%.

The weak numbers are from a massive capital expenditure as the company is quickly ramping up expansions of its pipelines and processing locations to handle the rapidly expanding US crude production. This looks all to the good as it is setting itself up to quickly expand.

However there is an overhang to the stock. On October 11 an SEC filing indicted that several original investors will be selling off 69,296,921 shares in a future public offering. There is no word yet on when this event will happen.

From the SEC 8K:

It is expected that the Selling Stockholders will sell all of their holdings of KMI common stock in the Offering. Neither KMI nor KMI's management is selling any shares of common stock in the Offering, and KMI will not receive any of the proceeds from the Offering of Shares by the Selling Stockholders.

Since this is previously issued stock it should not have a dilutive affect on earnings or dividends. However it likely will impact share price due to selling pressure. I think a price pullback is likely when the date is announced. This might provide an excellent buying opportunity.

Marathon Petroleum Corporation

Marathon Petroleum is a more diversified downstream energy company than those I have already mentioned. It is focused on the downstream oil segment with refining and marketing, retail marketing and transportation operations. It was spun off from Marathon Corp. (NYSE:MRO) in 2011.

Marathon's recent closing price was $53.05, within a 52-week trading range of $30.24-$60.04. It currently trades at a Price to Earnings ratio (PE) of 7.1 with earnings per share of $ 7.50. The company pays a quarterly dividend of $0.35 a share for a 2.65% yield, off a tiny and conservative payout ratio of 14%.

MPC Chart
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MPC data by YCharts

Marathon Petroleum has a current ratio of 1.42, a profit margin of 3.29% and an operating margin of 5.08%.

The company and its subsidiaries have been busy on acquisitions and business development. Speedway LLC, a wholly owned subsidiary of MPC, has been acquiring convenience stores, which helps the company to expand its presence in the retail segment as part of a broader expansion strategy. Marathon is working to close on the purchase of a Texas City refinery from BP (NYSE:BP) while it is also working with the privately held Harvest Pipeline to develop a truck-to-barge transportation project on the Ohio River.

The company will have almost 150,000 bpoe of upgraded refining capacity coming on line within the next three months. So long as crude stays above $85/bbl and crack spreads stay wide then revenues should accelerate in 2013.

This is a great investment for those looking for near term and long term growth.

Phillips 66

Diversified Midstream and downstream, Phillips 66 has been a market darling since it was spun off from ConocoPhillips (NYSE:COP) on May 1, 2012. The Houston based refiner operates across 15 refineries and has net crude oil capacity of 2.2 million barrels per day along with 10,000 branded marketing outlets as well as 15,000 miles of pipeline systems.

The Phillips 66 recent closing price was $46.21, within a 52-week trading range of $28.75- $48.22. It currently trades at a Price to Earnings ratio (PE) of 5.4 with earnings per share of $8.54. The company declared a dividend of 25 cents per share, payable December 3, 2012 to shareholders of record as of October 15, with an annual yield of 1%.

PSX Chart
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PSX data by YCharts

Phillips 66 has a current ratio of 1.29. It has profit margin of 2.75% and operating margin of 1.68%.

News has been coming fast and furious the last few weeks. On the upside the company's management reported a dynamite 3Q 2012. Earnings for refining and marketing were up 33% and the company smashed analysts earnings expectations by $0.62/share. However on the downside, the company's 238,000-barrels-per-day Bayway refinery in Linden, New Jersey remains closed after Hurricane Sandy with no word when it will reopen.

As an aside, the Bayway refinery is a prime example of a company like Phillips and their aggressive ability to take advantage of regional crude price arbitrage. During the company's 3Q earnings call, management discussed how it had been shipping Texas crude by rail car to the New Jersey refinery to take advantage of the lower feedstock prices.

If that wasn't enough, earlier this year, investing icon Warren Buffett's Berkshire Hathaway announced that it purchased 27 million shares of PSX.

What I love best about management is that they are using a good chunk of cash flow to invest in upgrading and modernizing its chemical division. While a money loser now, chemicals should be a strong growth element whenever the economy gets around to a recovery. Phillips is not only looking at today's economic environment, but it is readying to take advantage of the next stage.

I consider Phillips 66 to be a great buy for any investor with a mid-to-long term investment horizon.

Disclosure: I am long COP, PSX, HFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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