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Cheap undervalued Refiner

|Includes: Western Refining, Inc. (WNR)

Ok, you guys know I like the Oil business, Ive said that before. Why? Oil is indispensable to modern day living, almost everything we do requires it, it is a commodity in limited supply, and is dwindling.
However, oil by itself is worthless. To use oil as a fuel or for any other purpose, it must first be refined into its constituent products by a Refinery. The refinery business is cyclical, following supply and demand. The refinery is always buying Oil and the mandated percentage of oxygenante, ethanol, and refining the oil to its refined products, mainly gasoline, commonly called RBOB and distillates, which can be diesel or heating oil (HO), along with nominal quantity’s of other products such as napththa, lubricating oil, kerosene etc. One common formulae is the Nymex 3-2-1, which gives the use of 3 bbls Crude oil to yield 2Bbls RBOB, and one of either Diesel or HO, depending on prices prevalent at the time. Usually, a refiner will choose to make HO in winter as that is when its margins are strong. Thus it is a simplistic statement to observe that a Refiners profits are closely tied to the ‘Crack spread”, or the difference between what they can buy the raw product for, and sell the refined products for, as this is their ‘margin’ of profit.
To get a quick chart of the current crack spread, copy/paste this =(28*XRB)+(14*HO)-CL
into the radio bar that says "contract", then click "get chart" below, from this link
What you are seeing, is the profit of refining a barrel of oil and selling its products. As you can see, CS has ranged from about $2 to $14 per barrel, and is now $5.60, up from the bottom in late Sept09.
Ok, you say, all that is really great coursonc, but so what? Well, that is just a refresher on how the refiners basic profit margins work. To look at a bigger picture, we also need to see the price metrics on both gasoline and Crude, since the purchase of Crude is by far the biggest cost to the refinery.
Crude oil price is mainly controlled by OPEC. They control price by limiting or supplying Crude oil to the market, and can do so since over 60% of the Worlds oil is supplied by them. The World uses about 80.5Mbod, and, as per the EIA, they have supplied 29Mbod on average over the first 3 qtrs of 2009.
Opec has expressed satisfaction with Crude oil price where it is, in a range of $70-80 per barrel, thus I will conclude that Oil input price is going to be relatively constant going forward, with a slight upward tone due to continued dollar devaluation.
The usual reason that gasoline or distillate prices remain depressed, like all commodities, is due to high inventory supply. Thus, it is clear, that for refinery profits to increase, we need to see increased crack spreads thru higher gasoline and diesel prices, higher volumes produced, or a combination of both. Indeed, and I quote, this is exactly what is forcast by the EIA: “EIA projects the monthly average regular-grade gasoline retail price to rise from $2.55 per gallon in October to $2.70 per gallon this month. Generally higher crude oil prices through the forecast period contribute to an increase in the annual average gasoline retail price from $2.36 per gallon in 2009 to $2.81 in 2010, with prices near $3.00 per gallon during next year's driving season. Projected annual average diesel fuel retail prices are $2.48 and $2.94 per gallon, respectively, in 2009 and 2010. Higher forecast crude oil prices also raise the projected average household expenditures on heating oil this winter to $1,940 in this forecast, compared with $1,864 last winter.”
Here is what is really happening. The US is going thru its worst recessionary downturn in the last 40yrs, with over 10.2% unemployment contributing to low fuel use. Job related use of fuel is projected to be about 30% of the overall fuel demand, so continued high unemployment with its input on consumer discretionary income has also played a part.
The refiners have been hard hit. At first what they did, was to step up and accelerate their scheduled maintenance, and reduce the refinery ‘run-rate’, which is a percentage of what the refinery can actually produce, compared to what it actually does produce. Beyond a certain reduction, if inventory continues to climb, or demand worsens, the refiners have to start shutting down production. They can choose to hot idle, or actually ‘cold shutter’, a plant, and usually choose to close the most underperforming, or older, higher maintenance plants first. This is exactly what has already been happening. Sunoco mothballed Eagle point.
Valero, shut Aruba in June, and Bill is now is permanently shutting Delaware City, and reducing at Paulsboro.
Western, which has four refinerys, shut down Bloomfield
What this is doing, is shutting down Refining capacity, or the ability to produce products, right at the same time that Demand, in the way of increased driving and use of gasoline, Diesel and other fuel products is going to go up.
Initally, this increased demand will produce drawdowns in the relatively high inventory levels we currently have, but as levels get drawdown without being replaced, price, and thus margins will go back up. Refinerys cannot just instantly be turned on and off like a switch. It is my bet that we are going to overshoot on the shutdown side, and then scramble when demand returns.
From this chart, you can easily see that refinery utilization, as a function of operable capacity has been going down (80.89 to 79.44%), but overall both Finished Gasoline, and conventional production has gone up (8453 to 9056) and (5454 to 5963)
Here, you can see that we are averaging about 23.4 days of supply in gasoline, about 1.4 days more than last year.
I watch almost all of the non-major refiners in this space, namely VLO, TSO, SU,SUN,CVI,FTO,HOC,ALJ,WNR and DK. Usually, the most inefficiency in the capital markets can be found in the small caps, or stocks whose total market capitulation is $200M to $2B, the smaller, usually, the better. The reason for this is because we, the small investor, can beat the institutional investors that have restrictions from buying large quantities of any one issuer, thus becoming a large shareholder, or having to file with the SEC and disclose its transactions. That narrows my interest down to three plays.
Alon (NYSE:ALJ) has a market cap of $350M. Delek (NYSE:DK) is similar at $352M, and then there is Western Refining (NYSE:WNR) at $407M. A quick look at these three shows WNR having the lowest price/book at .51 vs .64 and .86 for DK/ALJ respectively.
You cannot pick a company on just one metric, sometimes there is a good reason its stock price is skewed in relation to others.
First, I looked at the debt: WNR has $1.07B debt with 89M shares or $12 debt/sh with .73 cash available. ALJ has $855M debt with 47M shares or $18M debt/sh with .39 cash available. DK had $342M debt with 54M shares or $6.3M debt and $2 in cash per share.
Then I look at Refining capacity. WNR has (4) refinerys, El Paso is 125Kbod, Yorktown is 70Kbod, and the two four corners combined are 40Kbod (one of which, Bloomingfield, is being shut, and ops transferred to the other, with no diminished capacity) 160 retail outlets. ALJ has (3) Gasoline refinerys and (1) Asphalt plant. Big Spring is 70Kbod, Paramount is 54Kbod, Long Beach is 34Kbod, and the Willsbridge Asphalt is 12Kbod. 300 retail outlets. For DK, they have just (1) refinery, a 60Kbod in Tyler, Tx, and a 34% interest in a private 75Kbod Lion refinery, and a whopping 450 retail outlets.
This somewhat explains the debt discrepancy between DK and the other two, as they are much smaller in Refining capacity, with more non-capital intrinsic retail outlets.
WNR total capacity is 235Kbod, ALJ is 170Kbod (12K is asphalt), and DK is 100Kbod(including their minority interest in Lion)
At this point, I am excluding DK, as they are too small, with too many retail outlets. If I wanted a retailer, I could choose 7-11 . Back to the debt. The debtload HAS to be serviceable. For WNR, it looks like it is. Western Refining generates operating profits more than sufficient to pay interest on its debt, even in this depressed market environment. Their operating margin is about 2.6% which is higher than most others. Their Q3 loss was less than expected, at $4.8M or .05 vs .06 per share, and the four corners ‘consolidation’ of two plants into ops of one, is expected to reduce expenses $25M per year. Bloomfield could be used for Biofuels, later. As of Sept30th, they have zero borrowings under the revolving credit facility. Capex was reduced from $155M to $120M, with $100M projected for 2010,and interest expenses are about $34M/Qtr.
They raised $180M recently by selling 20M shares at $9. The CEO is the largest individual shareholder, at over 8M shares, so he has a vested interest in turnaround, and he was buying at $9 back in Jun09. Total insider interest is high, at about 41%.
When Reading technicals, WNR is severely oversold here at sub $4.50, with RSI of 29 and about 17 down days in a row, way below the 50dma of $6 and I think the severe pessimism is unfounded and unwarranted. If my overall view is correct, and the US economy is pulling out of this recession, it will mean more fuel needed for those drivers going back to work, and at higher prices, meaning higher margins, and more profit for the refiners.
As an additional bonus, WNR has zero exposure to any kind of Hurricane or weather related risk, as ALL of their plants are located inland, away from GOM, and served by stable pipeline, or inland barge.
Weather mishaps that reduce capacity to other refiners are always a good event to WNR, by raising product prices.

Current Short interest is 9.3M shares, or 18% of of the Float of 52M shares, which by comparison is much higher than ALJ with 2.8% shorts. DK is 2% short. VLO is also 2.8% short right now. This makes WNR a short squeeze candidate on any good news.

I recommend a BUY on WNR sub $4.55 as a play on the recovery of US out of recession. Cheers! Disclosure, Long WNR.