3 Energy Refiners To Consider, One to Buy

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Jan 29, 2015
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A) Introduction

While crude collapsing from $105 to $50 has hammered oil producers, energy refiners have been having their moment in the sun. Oil refiners tend to benefit when crude oil falls in price, as it is their main input cost. Whereas gasoline prices at the pump tend to be "sticky", in that they react to changes in international oil prices relatively slowly. Thus, oil refiners are able buy crude at cheap prices while selling gasoline at relative higher prices. This leads to an increase in margins, and corresponding increase in profits. In this article, we're going to be analyzing three different US crude refiners to see which one comes out on top. They are:Â Valero Energy (VLO), Marathon Petroleum (MPC), and Tesoro Corporation (TSO). We will be looking at their valuations, growth profile, how the "smart money" on the street is playing each stock, and concluding with some qualitative analysis and conclusions.

B) Value Breakdown

We take a quantitative approach to investing, preferring to focus our analysis on a certain set of metrics that have a strong predictive ability. We'll start by analyzing each of the crude refiners value profile. This is important to look at as "Value stocks (with low ratios of price to book value) have higher average returns than growth stocks (high price-to-book ratios)". These valuation profiles are shown below:

Table 1.1 - VLO Value Breakdown

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Table 1.2 - TSO Valuation Breakdown

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Table 1.3 - MPC Valuation Breakdown

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Each of the three refiners is wildly undervalued on a revenue basis, with each of them boasting a minimum sales yield of 400%. This means investors can get $4 of revenue for every $1 they invest. This is way higher than the Oil, Gas, & Consumable fuels average of 38%, and overall energy sector average of 21%. This relative undervaluation holds true on an earnings, book value, and free cash flow basis, with each of the three refiners having an earnings yield of +6.5%, price/book of less than 2.3, and price/FCF of less than 21. Each of these minimums are more attractive than the industry group, sector, and overall market averages. Valero Energy looks especially undervalued, registering a very low price/book of 1.3 and price/free cash flow of 7.95 to go with an extremely high sales yield of 526% and earnings yield of 13.6%. There is no doubt that the market has punished these stocks over the last few months, and their valuations reflect that. Overall, we rate each of these stocks as 'Strongly Undervalued', with Valero Energy expected to outperform the market the market the most (12.4%) due to the undervaluation.

C) Growth Breakdown

There are a variety of different growth metrics that have been shown to predict stock returns. Most important among them is price momentum. Winning stocks keep winning, and losing stocks tend to keep losing. The three refiners growth profiles are shown below:

Table 2.1 - VLO Growth Breakdown

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Table 2.2 - TSO Growth Breakdown

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Table 2.3 - MPC Growth Breakdown

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Given the impact that the collapse in crude had on the energy sector over the last six months (-35%), each of the three refiners has held up very well with VLO gaining 5%, MPC up 13.5%, and TSO posting a 35.8% gain over the same period. As we showed in the link to the academic paper above, stocks with strong price momentum tend to outperform the market by a wide margin. Given that each of these stocks has beaten the overall market averages over the last six and twelve-month periods, this is a great sign of continued outperformance. Tesoro looks the strongest of the pack, having gained 35.8% over the last six months and 63% over the last twelve. On a growth basis, both MPC (-33%) and TSO (-53%) have seen annual EPS take big hits, while VLO grew by 33% (in line with the industry group average of 29%). All three refiners posted strong return on equities, with the lowest of the three (TSO at 16%) still being more than double the industry average of 7%. Overall, we see each stock outperforming the market by a moderate amount due to their favorable growth stats. TSO is the strongest growth of the three, and we see them outperforming the market averages by 5.5% due to the strength of its growth characteristics.

Smart Money Breakdown

In addition to value and momentum, we will also analyze how the "smart money" on the street is playing each of the refiners. "Smart money" stakeholders are short sellers, company insiders, and institutions. Each of these stakeholders tends to be much more sophisticated than the average investor. We have found loads of academic research showing that short sellers, company insiders, and institutions all predict stock returns. These breakdowns are shown below:

Table 3.1 - VLO Smart Money Breakdown

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Table 3.2 - TSO Smart Money Breakdown

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Table 3.3 - MPC Smart Money Breakdown

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Once again, the three refiners all boast stats that are much better than the industry group average. One thing to note though is the worrying amount of company insider selling coming from Tesoro (-15% in company ownership over the last six months). A deeper look into the actual company transactions reveals that most of this selling comes from option exercise sells, which aren't as worrying as outright dumping of the stock. Tesoro also boasts the highest short interest of the refiners at 7.75% of the float, though that is still below the industry group average of 8.13%. Each of the three refiners has seen slight increases in institutional ownership over the last three months, which is also a positive sign. Overall, MPC has the most attractive "smart money" profile of the three with extremely low short interest (2.75% of the float) and slight accumulation by both institutions and insiders.

D) Qualitative Analysis & Conclusions

As always, we will finish our quantitative breakdown with a qualitative discussion of potential growth catalysts and business risks that three refiners face. As we mentioned at the start of the article, refiners tend to benefit from lower crude prices as their costs go down while their revenues at the pump stay relatively static. There is also an extra benefit to lower prices: higher demand. As mentioned by Marathon Petroleum CEO Gary Heminger in a recent interview, lower gas prices have led to increased demand from consumers for gas. This is also reflected in the surge of SUV sales, which obviously require larger amounts of gas than regular vehicles. Thus, refiners are benefiting from increased revenues (from the increase in demand) while also seeing a widening of margins. Refiners look poised for big business numbers in 2015.

Overall, we feel each of these three refiners offers good value along with solid price momentum, and strong rates of return on equity. With that being said, if we had to choose between the three we feel Marathon Petroleum represents the most attractive opportunity. While Tesoro offers the best combination of value and growth, their high short interest and company insider selling is a worrying sign. Statistically, it's a bad bet to trade against high short interest and company insider selling, and this risk is not present in the other two refiners. It's extremely hard to pick between Valero and Marathon, but we give a slight edge to Marathon. Both companies have very low debt to equity ratios (each at 32%), and are not in immediate danger of insolvency. But Marathon has better price momentum, Return on equity, and isn't seeing moderate company insider selling. Overall, we rate Marathon Petroleum as a "Strong Buy", and expect the stock to generate significant outperformance in 2015. Investors looking to learn more about our analytical style can check us out here.