Many stocks have roared out of the lows they hit last December. At the time, the perma-bears were out in force stating that the bull market was over and that the corresponding bear market had begun in earnest. Stocks, though, defied the critics once more, which resulted in a fierce rally of well over 400 points on the S&P 500.
Although the S&P is most likely dropping into a daily cycle low at present, we believe that this index should take out its all-time highs in the next month or so. When stocks are trading at all-time highs, stock picking can become more difficult because, obviously, one has less cheap stocks to pick from. One stock we are watching at present is Delek US Holdings, Inc. (DK). This refiner presently trades with an earnings multiple of just over 8, which is well behind the industry average of just under 11. Furthermore, the firm at present pays out a 3.1% dividend.
Although the firm, from a valuation standpoint, looks attractive on the surface, we are always cautious when investing in stocks with low price to earnings ratios. Either the business is in trouble or the market is mistaken about this stock. We obviously hope it is the latter which is why we research the dividend, the valuation more closely and also earnings trends. Let's dig in.
We always start with the balance sheet when evaluating the dividend. When a balance sheet has too much leverage, the dividend over time can come under pressure if hard times were to hit. Delek US Holdings has a debt to equity ratio of 1.07. Although attractive, we usually look for under 1 with our value plays. There is over $1.7 billion of long-term debt on the balance sheet, which is slightly higher than the firm's shareholder equity ($1.63 billion). Combined liabilities of the firm though come to $4.13 billion. Therefore, the total liabilities to equity ratio come in at a much higher 2.53. Really conservative investors also look for this metric to be under 1, which we do not have with Delek US Holdings at present. In saying this, the cash dividend payout ratio is around 33%, which means the dividend is not in any trouble at this present moment in time.
We can see the impact the firm's debt is having on the income statement through the interest coverage ratio. This ratio tells us how much interest (the firm must pay on interest bearing debt) is coming from the firm's pre-tax profits. At present, the interest coverage ratio comes in at 4.86, which again would be slightly below what we would be looking for. Generally, companies with interest coverage ratios under 5 rely more on their earnings to keep on paying out an increasing dividend.
Speaking of earnings, Delek US Holdings' record over the past 10 years has been patchy, to say the least. The company did not make any money in 2008 and reported negative earnings of $1.47 per share in 2009. Furthermore, in 2016, the firm reported a negative $2.49 EPS number, which again resulted in elevated selling of shares. Valero (VLO), being a far bigger company in this space, has been able to post positive operating income every year over the past decade. Suffice it to say, this builds confidence for the dividend and beyond and explains the company's higher valuation.
Analysts' expectations are not something we would go on in the refining sector. The industry is highly volatile, which means earnings predictions can change very quickly. What you are getting here though with Delek is a company trading below the industry average and which has its dividend and financials intact for the most part. Nevertheless, we would be looking for more of a "deal" from a company with a $2.5 billion market cap. Although Valero has a higher valuation at present, Phillips 66 (PSX), for example, is a far bigger refiner than Delek but also has a similar valuation. For investors who are long at present, that $30 level needs to hold.
Elevation Code's blueprint is simple. To relentlessly be on the hunt for attractive setup's through value plays, swing plays or volatility plays. Trading a wide range of strategies gives us massive diversification which is key. We started with $100k. The portfolio will not not stop until it reaches $1 million
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.