On Wednesday, I filled up my gas tank at $2.51. On Thursday night, the price was $2.99. It jumps around like that sometimes, as everyone knows. It got me thinking, though, crude oil barely budged over that day, and indeed it went down slightly.
In covering the oil refinery industry, the key metric is called the 3-2-1 crack spread. In short, this is the spread between the cost of three barrels of crude oil and the products that are produced from it, two barrels of gasoline and a barrel of home heating oil. Everyone knows oil's been getting hammered over the past month. Gas and heating oil dropped too, but not so much.
All this adds up to a rising 3-2-1 crack spread, which is still a bit off its highs during that ridiculously cold February, but is still sitting well above this time last summer, and these last few months are the best it's been in a couple years.
So today we're going to be looking at three big refinery plays in the US market, Marathon Petroleum (NYSE:MPC), Phillips 66 (NYSE:PSX), and Valero (NYSE:VLO), comparing their financials, and looking to see if we, as investors, might want to get into the refinery market to take advantage of this strong spread, and the strong future earnings the spread implies.
By the numbers part 1: The balance sheets
At the risk of oversimplifying things, I suggest we treat all three companies as essentially the same. They're all North American refinery companies, after all, and while some of the particulars may vary, they are each at their core in the same business, taking crude oil and turning it into refined products for resale.
Taking all three as roughly analogous, we can then look at the book values in an apples-to-apples manner to try to figure out which is the best bargain.
|Cash||$2.0 billion||$5.3 billion||$4.8 billion|
|Assets||$30.1 billion||$49.0 billion||$45.7 billion|
|LT Debt||$5.9 billion||$8.9 billion||$7.2 billion|
|Equity||$11.3 billion||$21.7 billion||$20.7 billion|
As you can see, all three are well capitalized. Marathon is the smallest of the three, and has the highest debt ratio, but is also trading at the smallest premium to its book value. Valero has the lowest debt ratio, and a sensible book value as well. Phillips 66, the largest of the bunch, commands by far the highest premium. To understand why, we'll be digging deeper into the numbers.
By the numbers 2: Earnings and dividends
With the crack spread improving, we can also expect the companies' margins to improve substantially. That said, while the price of refined products didn't drop as much as the price of crude, everything dropped quite a bit, so these companies are all looking at higher margins on much lower revenues, which means their earnings aren't necessarily going to grow.
|Revenue||$98.1 billion||$161 billion||$130 billion|
|Op Income||$4.0 billion||$5.7 billion||$5.5 billion|
|consensus 2015 EPS||$5.64||$6.59||$6.88|
As you can see, Marathon pays the best dividend, but the current analyst estimates for their FY2015 is the lowest of the bunch. Valero is the most stable from 2014-2015, but has the weakest yield, while Phillips 66 splits the difference.
A lot of the wiggle room in prices lately has been those consensus estimates moving around, generally trending upward for all three as the crack spread improves, but the fastest for Philips 66. That's not surprising, Phillips 66 is the biggest company and doubtless the best covered, and these improving estimates are a big part of why it commands a relative premium.
That said, Valero and Marathon are seeing their respective estimates rise too, and so long as the crack spread remains where it's at, those estimates should continue to rise going forward, meaning improvements in price for all three.
So long as the crack spread remains strong, the refineries are all substantially undervalued to their earning potential. 2014 saw an extremely bad spread, and by extension extremely bad margins. The market in these stocks is just starting to catch up to the commodities market, and barring anything unforeseen, any of them would make a fine investment.
Ultimately, I'm going to pick Marathon as the best of the bunch, with the best yield and lowest price/book ratio. It's smaller than the other two, but feels more discounted.
Valero also deserves strong consideration, both for having the lowest debt/equity and the best operating margins in the depressed 2014 environment. For me the big difference is that their dividend yield is half what Marathon's is, but if you're not so worried about near-term income, it might be the better company.
Phillips 66 is a fine company too, but I'm least interested in it because it feels like it was never beaten down as seriously as the other two and doesn't offer the more substantial value proposition they do.
Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in MPC over the next 72 hours. 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.