Back in the spring, I suggested that pint-sized Frontier Oil (NYSE: FTO ) was the best bet among risky refiners. Later, commenting on first-quarter results, I cautioned investors not to get burned by chasing then-hot shares. Two things have since changed my last writing: The stock is down roughly 15%, and the company's swung to a third-quarter loss.
Despite all that, I continue to view Frontier as a top-tier independent refiner. Unlike with industry giant Valero (NYSE: VLO ) , Frontier's investors haven't been scalded by common-share dilution. Compared with names that include Sunoco (NYSE: SUN ) , there's been no dividend cut. And unlike fellow regional player Holly (NYSE: HOC ) , management hasn't tapped the debt market in more than a year. In fact, Frontier ended the quarter with $487 million in cash, an untouched credit line, and an exceedingly conservative debt-to-capitalization ratio of 23%.
Now for the bad news. The company posted a loss of $0.15 per share, versus earnings per share of $0.70 in the year-ago period. Sequentially, the earnings spill compares to second-quarter EPS of $0.47. Of course, Valero and Sunoco shareholders recently saw EPS dip even further into the red. Also, investors will be glad to know that Frontier remained cash-flow positive, even if at a fraction of the second-quarter figure.
Crude differentials, although still down dramatically year over year, moved in the company's favor from the prior quarter. Refining margins were also down on an annual basis, owing to weak demand and high inventories. Sequential margin change, however, was mixed: The diesel crack spread widened while the gasoline spread narrowed. With company yield and sales skewed toward gasoline, that wasn't the most favorable development.
Finally, to better understand the yawning earnings gap from quarter to quarter, investors should note that in the second quarter there was an inventory gain of $0.75 per share, compared to a far smaller $0.08-per-share benefit in the recently completed period. Put simply, when crude prices rise substantially during a reporting period, Frontier recognizes a large gain, reflecting the difference between prices paid and the quarter-ending market value of finished and unfinished product. In the third quarter, crude rose less than it did in the second -- hence the difference in per-share benefit.
Going forward, management is looking to improve profitability through efficiency upgrades at its Cheyenne refinery, which are targeted to lift refining margins by $3-$4 per barrel by mid-2011. Also, the company is keen to make an acquisition, although it isn't hopeful that a "high-quality asset" opportunity will be available anytime soon.
Finally, management doesn't see refining fundamentals recovering until "well into 2010." And that thesis rests partially on the assumption that larger competitors will keep recently closed refineries shuttered. In addition, I'll remind investors that integrated giant BP (NYSE: BP ) also sees weak fundamentals ahead, and that fellow Fool Toby Shute has profiled ExxonMobil's (NYSE: XOM ) peak gasoline perspective.
Bolstered by a rock-solid balance sheet and historically strong pricing power, Frontier should hold up better than most. Furthermore, barring consecutive quarterly losses into 2010, developing an interest in shares at a current price-to-book of 1.2 is probably not tantamount to trying to catch a falling knife. Still, be aware that you could get cut.
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