Refiners Remain The Sweet Spot In Oil

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Includes: HFC, PSX, VLO, WNR
by: Dana Blankenhorn
Summary

Investors have piled into refiners during the oil glut, but there is more room to run.

Refiners can export their product and switch to U.S. feedstocks, and some have their own retail operations.

This is the market sweet spot.

Investors who bought refinery stocks while oil was below $50/barrel are looking pretty smart right now. But there is still time to get in, even as oil prices rise to a new equilibrium somewhere in the $60 range.

Companies like HollyFrontier (NYSE:HFC), Valero (NYSE:VLO) and Western Refining (NYSE:WNR) are all up over 10% so far this year, despite single-digit price/earnings multiples. They remain below 10 despite that run-up, meaning they have much more room to run.

This remains the case because, with falling oil prices, the revenue figures for refineries plunged along with those of the oil drillers. But the refiners managed to make a profit at those prices. Western Refining brought in $134 million on revenue of $2.3 billion. HollyFrontier earned $268 million during the March quarter on revenue of $3 billion. Valero made $964 million on revenue of $21.3 billion.

Those top lines should be up substantially for the June quarter, and so should the bottom lines. Consumers may have been shocked when pump prices rose from around $2/gallon to near $3/gallon this spring, while crude prices were going from just about $50/barrel to a little over $60/barrel. But smart investors knew that, while you may not be able to directly export U.S. crude to foreign markets, it's perfectly fine to export refined product. Refiners who could use the light, sweet product coming out of fracked wells were particularly at advantage because they not only earned the "crack spread" - the difference between the cost of oil coming in and the value of refined products going out - but also the "WTI spread," which is the difference in price between the U.S. standard for oil and the world standard.

Another advantage held by some refiners over others is their retail networks. Just as Lululemon (NASDAQ:LULU), Apple (NASDAQ:AAPL), and Comcast (NASDAQ:CMCSA) (CMCSK) gain advantages from vertical integration - controlling both their supply chains and distribution channels - so it is that refiners like Valero, Marathon (NYSE:MPC) and Philips 66 (NYSE:PSX) are able to sell what they make. These refiners earn the premium multiples. PSX, which earned $987 million last quarter on revenue of $22.8 billion, and Marathon, which had net income of $891 million on revenue of $17.2 billion, could do a better job of running those gas stations in my view. But they do have multiple ways to profit from their production, and thus in my view represent the best value in the group.

These stocks are going to remain volatile. There will be days when they go down. But the technical "undervalue" on these stocks is minimal, and the potential gains, both organically and from potential acquisitions, remain better than in any other sector.

So, to summarize: refiners are cheap. They can export. Some have their own retail networks. My favorites are those whose names you see on the roadside - Valero, Marathon, and Philips. But you can buy all these names right now with both hands and expect many happy returns by this Christmas.

Disclosure: The author is long CMCSA, AAPL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.