- Refiners have taken the punishment from COVID-19: Despite a rebound along with other areas in the past week following positive vaccine news, they're doing worst among coronavirus-impacted sectors, J.P. Morgan says.
- Year-to-date, refiners are down 52% and the Energy Select SPDR (NYSEARCA:XLE) is down 39% vs. an S&P 500 up 12%. And investors are picking a lane as far as determining what's next: "(a) whether the shale-induced crude oil differential profit joyride is over and the EV revolution is upon us to (b) whether capacity closures and a vaccine will allow margins to normalize and drive continued share price upside against the backdrop of a value rotational trade."
- The real answer is somewhere in the middle, analyst Phil Gresh and team conclude. The fourth quarter and Q1 of 2021 aren't likely to be much better than the middle of 2020, with mobility, demand for refined product and crude differentials all hurting from pandemic issues.
- But: The second half of 2021, with an effective vaccine, promises some kind of rebound. That means a base case of a "normalized" 2022 framework (accounting for crude differentials and product margins still depressed below 2019 levels), the team says.
- Capacity is key, J.P. Morgan says. Its rolling tally of announced closures is more than 2M barrels per day, and the firm expects another 2.5M bpd or so is necessary to keep 2022 capacity in line with 2019. Then the market would be fairly balanced (if demand has returned to pre-COVID levels by 2022).
- And "on demand, key markets like China and India have already seen months above pre-COVID-19 levels, though developed markets have lagged," the firm says.
- Back in the U.S., cutting demand declines back to low single digits for gasoline and diesel would let utilization hit the mid- to high-80% range, driving a call for "another 500-1,000kbd of U.S. closures to allow refiners to better control their own destiny."
- The recent bounce indicates about 11% total return potential by the end of 2021 on J.P. Morgan's below-consensus estimates; with stocks then "basically re-rated to consensus," more upside will depend on fundamentals.
- And that reinforces its Overweight stance on Phillips 66 (NYSE:PSX) and Valero Energy (NYSE:VLO). PSX has been "less defensive than we hoped" due to refining weakness, but earnings should still hold up relatively well aided by portfolio diversity. Even its bear case allows for positive free cash flow, with a strong balance sheet and liquidity, and growing capex flexibility in the coming year. It's a "best-in-class large-cap Energy company that should compete with the large-cap oil majors and E&Ps for investor capital moving forward."
- As for Valero, it's a pure-play refiner that's made good strategic decisions and just needs "some macro help." With no MLP subsidiary, and a strong balance sheet, it can endure an extended downturn, the firm says - with its key risk being if free cash flow stays negative, the dividend will have to come from the balance sheet.
- And it's Underweight on Delek US Holdings (NYSE:DK), Par Pacific Holdings (NYSE:PARR) and PBF Energy (NYSE:PBF). Narrow inland crude differentials will remain a challenge for Delek given a near-100% exposure to inland fundamentals, and a suspended dividend means investors aren't being paid to wait. Par Pacific has areas for EBITDA improvement in retail/logistics along with HI Refining, but cracks should stay challenged for Hawaii, to which Par has a heavy exposure.
- And PBF may be most exposed to product market fluctuations with its group-low margins - and it's always most exposed to light/heavy crude differentials, which should stay tight. The firm's base case doesn't show PBF earning more than $1/share in EPS in the foreseeable future.