It's been exactly six months since the publication of our article that rated Marathon Petroleum Corp. (NYSE:MPC) as a strong investment opportunity and the best stock to buy in the energy refiner space. It's now time to review the results since the initial thesis and determine whether Marathon is still the best refiner moving forward.
In our initial article, we compared Marathon Petroleum to Valero Energy Corporation (NYSE:VLO) and Tesoro Corporation (NYSE:TSO) on a variety of different metrics. We determined that both Marathon and Valero were attractive investments but gave a small edge to Marathon, based on its stronger rates of profitability and lack of company insider selling. Marathon also had a lower level of short interest, and had been experiencing strong price momentum, both of which are typically signs of future outperformance.
Our initial article was published on January 30, when Marathon was trading at $45.25. The stock closed this Friday at $54.67, representing a gain of 18.2%.
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All three energy refiners listed in our article have outperformed the overall market by a wide margin since, gaining an average of 22.3%. Marathon was actually worst performer of the group, gaining 18.2% since publication, versus +21% for Tesoro and +28% for Valero.
Our perspective on the broad industry trends that are propelling energy refiners higher remain the same from our initial article. Low crude prices generally help refiners, as gas prices charged at the pump tend to remain "sticky." This means that energy refiners get to buy crude (their main input) at cheap prices, while selling gas at relatively the same prices as before (leading to an increase in profit margins). This has largely played out, with both Valero and Marathon experiencing widening margins. Expect that trend to continue as long as crude price remains depressed.
To determine which refiner is the most attractive opportunity moving forward, we'll be analyzing the valuation, profitability and momentum profiles of Valero and Marathon. We'll start by comparing each stock using five different value metrics to determine which one is cheaper:
(Data Source: QuantifiedAlpha.com)
(Data Source: QuantifiedAlpha.com)
Marathon and Valero are extremely cheap on a sales and earnings basis. Both have sales yields near 300%, meaning that their annual sales are three times larger than their current market cap. Valero sports an 14% earnings yield, which is almost four times the current market average.
Valero is the higher-yielding of the two, with a dividend yield of 2.44%, versus 1.83% for Marathon. Valero is also cheaper on a book value basis, with its P/B multiple of 1.57x, versus 2.48x for Marathon. Lastly, Valero is cheaper on a free cash flow basis, with an FCF yield of 23%, versus 17% for Marathon.
On average, relatively cheap stocks have historically generated excess returns over relatively expensive stocks. Our algorithms expect that value premium (i.e., value alpha) to be 5.72% for Marathon and 7.76% for Valero. Both stocks are still quite cheap relative to the market, but Valero is the cheaper of the two.
Advantage: Valero Energy
Next, we'll analyze the growth of both companies, concentrating on price momentum, earnings growth, and profitability:
(Data Source: QuantifiedAlpha.com)
(Data Source: QuantifiedAlpha.com)
Marathon and Valero have been strong performers recently. Marathon's stock price has gained 19% over the last six months and 34% over the last 12. Valero's performance has been similar, having gained 26% over the last six months and 32% over the last 12.
Marathon has seen the bigger increase in earnings, though, with trailing 12-month earnings 72% higher than earnings during the same period a year ago. Valero's earnings have grown 52%. Marathon is also slightly more profitable, returning 28% on equity and 11% on assets, while Valero returned 22% and 13%, respectively.
On average, stocks that have excellent price momentum and/or strong profitability typically generate significant excess returns over the market. Our algorithms expect that growth premium (i.e., growth alpha) to be 4.78% for Marathon and 4.49% for Valero.
Advantage: Marathon Petroleum
Next, we'll analyze the companies' business quality, concentrating on their level of earnings accruals, external financing, and CAPEX:
(Data Source: QuantifiedAlpha.com)
(Data Source: QuantifiedAlpha.com)
We'll spend less time on business quality, as we don't expect to see it materially impact returns moving forward, and the companies' stats are pretty much identical. The key thing to note is the -5% change in external financing for Valero. This metric measures cash in/outflows from debt or equity. The negative number represents Valero's heavy share buyback plan and relatively neutral cash inflows from debt over the last 12 months. Companies that pay down debt and/or buy back shares have historically outperformed those that are heavily indebted and issue secondary offerings. Marathon also has a share buyback plan, but has relied on debt for cash flow (especially in Q3 2014).
Advantage: Valero
Overall, we feel that Valero is the better pick within the refiner space, as it trades at a much cheaper valuation, has a higher dividend yield, and has actually had net cash outflows from debt and equity over the last twelve months. Marathon isn't a bad pick either, but we wouldn't recommend it as an investment opportunity at this point.
This brings us to our projected 12-month price targets. Our equity pricing model use historical backtesting to predict the amount of "excess returns" (i.e., alpha) a stock will generate. It combines this with the stock's beta to project a range of 12-month target prices. This range is expected to have a 75% area of accuracy (i.e., the stock price will be within the price range 75% of the time).
These projections are shown below for Valero Energy:
(Data Source: QuantifiedAlpha.com)
In our base case, the Quantified Alpha algorithms expect Valero to rise from its current price of $65.50 to $74.99 over the next twelve months (representing a gain of 15%). Our algorithms project a 75% probability that the company's stock price will be between $51.91 to $100.84 in 12 months. This wide range in possibilities reflects Valero's high beta, which measures market risk. Our projections are right in line with Wall Street analysts, who currently have an average 12-month price target of $75.36.
The risk-reward of the investment is not as attractive as it was six months, but we still see significant long-term upside in Valero moving forward. Buy VLO.
