Oil Refining Stock P/E Multiples

by: Chris Damas

Since I wrote about the independent US oil refiner stocks last week, they have shown impressive relative strength, ignoring a 130 point sell off in the DJIA yesterday, and moving up today with the 99 point rally.

I know when I am wrong to sell and last week was one of those times.

In my defense, I am cautious and have a number of projects on the go.

The price earnings multiples on the oil refining stocks are single digit based on analyst 2013 consensus estimates as the table below shows.

With commodity stocks, including oil refiners, you often get the lowest multiples when earnings are at a cyclical peak, and are about to crater.

But the refiners have a good chance of providing earnings growth for longer than a year, in spite of the intra-year seasonality of refining product demand and crack spreads.

Here is a list of their P/E multiples based on analyst estimates compiled by S&P/Capital IQ:

U.S. Oil Refiner Multiples
Symbol Feb 5 2013 EPS P/E 2013
MPC $76.68 $10.12 7.6
HFC $54.29 $6.79 8.0
NTI $26.44 $3.28 8.1
TSO $50.23 $5.90 8.5
PSX $61.01 $7.10 8.6
VLO $45.70 $5.77 8.9
DK $36.01 $3.95 9.1
ALDW $24.50 $4.75 5.2

There are a few obvious events that could send these stocks into a tizzy, but I think the increasing wave of domestic and Canadian oil supply combined with substitution of more expensive off-shore grades, plus greater Gulf Coast exports of refined products, will overwhelm short term negative effects.

First, John Kerry in the State Department probably means the northern leg of the TransCanada Corporation (NYSE:TRP) Keystone XL pipeline will not get approval. What would have little real impact right away because it would take a couple of years to build anyway. But limiting pipeline build-out ultimately means the Canadian heavy supply will be more limited than otherwise.

Second, I think there is environmental risk especially with positions yet to be filled heading up the Department of the Interior, the EPA, and the Department of Energy.

One of the first things I do when I look at a plant or an oil refinery, is I check out their emissions profile on TRI Explorer, which lists emissions for major source industrial facilities across the nation. I also check with the state environmental regulatory authority, to see how the company is faring in their compliance with their permits and whether any permits are being violated or even revoked, or alternatively, what expansions of their operations are being permitted, which could lead to growth.

Climate change hawks and more vigilant federal Greenhouse Gas emission rules would increase compliance costs for oil refineries. That could be a good thing. But it would also be expensive and cut into profits. The refiners already spend a lot of money on turnaround and regulatory expense.

Another issue that could suddenly appear: one train derailment carrying oil could cause a high profile disaster and this would "derail" attempts to get more Bakken crude or Canadian or bitumen delivered to coastal refineries. We already had a barge accident which leaked oil into the Mississippi. A big fireball and a hazardous oil spill could be a problem, and I dare say, is more or less, inevitable, given all the traffic on the rails and rivers these days.

Environmental activists have already started sending letters warning politicians they mean to fight increased rail traffic carrying oil to refineries through their communities.

As a side note: I helped fight a corn ethanol refinery right here in beautiful Barrie, because the promoters knew nothing about what they were doing, and the site was inappropriate, being close to homes, stores and offices. I covered the rail freight side of things amongst others. So I have more than a passing knowledge of how people feel having hazardous or toxic liquids freighted within spitting distance of their bedrooms.

One financial issue is with regard to the "sequestration" and the debt ceiling. There has been noise about increased tax payments being required of the refinery companies, from changing the rules regarding LIFO inventory profits, to repatriation of foreign profits, to accelerated depreciation of major equipment. These initiatives could threaten to take a bigger bite of the new found profitability of these operators.

Having said all that, I think the EPS multiples on the independent refinery stocks could easily go to double digit. I haven't done a historical study of where their multiples have been in the past, but I think that is, to a certain degree, irrelevant, because we've never seen a situation where the U.S. and Canada were pumping out this much oil relative to the amount of refining capacity capable of taking it.

That would mean a serious uplift in stock prices from here - or about 32% for Marathon Petroleum (NYSE:MPC) down to 12% for Valero (NYSE:VLO). Earnings per share estimates are being raised quickly in most cases, so if these also go up, you could see gains that are even greater than just from multiple expansion.

The valuation of the MLP's is a bit more tricky, because they are so popular with retail investors, who prize the quarterly distribution flow. The MLP's get a premium valuation due to the tax-advantaged treatment of the distributions and the high yield which reduces investor risk aversion. I know from my experience with the fertilizer variable pay MLP's such as Rentech Nitrogen (NYSE:RNF) and CVR Partners (NYSEMKT:CVR), that a good MLP can really soar in price.

Many of the big cap names have share buybacks in place, and I suspect they are being executed quickly due to the large amounts of cash sitting on their balance sheet. MLP's are forecasted to pay out significant distributions.

Marathon Petroleum for example, had an average 2013 estimate of $9.06 on January 10; it was just revised up to $10.12 in successive steps over the past four weeks.

A short-term technical driver of the stocks is the 2013 Credit Suisse Energy Summit which got underway in Vail, Colorado yesterday. Phillips 66 (NYSE:PSX) has already presented, and focused on their plans to rail more oil. Marathon, Chevron (NYSE:CVX), and Valero are all presenting tomorrow afternoon. Alon USA Partners (NYSE:ALDW), Delek US Holdings (NYSE:DK) and Northern Tier Energy (NYSE:NTI) are doing "one-on-ones". Finally, Tesoro (TSO) is reporting Q4 earnings on Wednesday after the market closes.

Most of these companies and LP's have posted updated investor presentations on their websites or on EDGAR, or both, and make for interesting reading.

If I forgot to mention your favorite oil refinery stock or MLP, please forgive me. It seems this is one of those times when all boats are rising due to the wave of crude oil washing down upon them.

Disclosure: I am long MPC, NTI. 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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