These 3 Refining Stocks Will Crush the Market

The oil and gas industry has been going through various upheavals. The last 12 months especially have been pretty eventful, with fluctuating supply (or maybe just fears of fluctuating supply) and steadily increasing demand causing marked unpredictability in crude oil prices. In particular, the refining industry has been bearing the brunt of the volatile markets. However, that's exactly where I see a huge opportunity waiting to be exploited. Let me explain how.

The first thing that needs to be understood is that the different crude oil benchmark prices have not been the same at any time. The two most popular benchmarks -- the West Texas intermediate, or WTI, and the Brent crude -- have been trading with a significant difference in prices. Brent crude has been trading at a premium compared to the WTI variant in 2011. The resulting difference between the prices of each of these blends (called the Brent-WTI spread) has been significant enough to impact refining margins.

Here's how the spread looked in the past six months:

Source: Energy Information Administration.

We see that WTI crude has been trading at a significant discount compared to Brent. From late August to mid-October, the spread was a solid $25 or more per barrel. More or less, those refiners processing the WTI had access to cheaper raw material. And hence, they are the cash kings.

However, the amazing part is this: The stock markets never recognized this in the past six months. In fact, Mr. Market has been largely driven by sentiments such as the Seaway pipeline reversal, the Keystone XL pipeline delay, and non-utilization of full capacity in some refineries. Sound fundamentals have never been entirely the basis of stock movements in the past few months.

So which of these refiners process WTI crude? They are the ones with refineries in the mid-continental belt. The following table shows how the market underestimated these stocks:

Company

Stock Returns in the Last 6 Months

Trailing P/E

Average P/E in the Last 24 Months

Western Refining (NYSE: WNR  ) (24.4%) 7.7 32.8
HollyFrontier (NYSE: HFC  ) (26.3%) 4.3 58.6
Marathon Petroleum (NYSE: MPC  ) (18.8%) 4.4 6.1
Valero Energy (19%) 5.2 14.5
Tesoro 24.7% 5.0 11.0

Sources: Yahoo! Finance and S&P Capital IQ.

The numbers tell us one thing. Refining stocks are oversold. But out of these, I'm particularly interested in those companies whose major refineries are located in the mid-continental belt of Texas, Louisiana, and Oklahoma.

Stock  No. 1: Western Refining
Overall refinery gross margin shot up by an astounding 137% from 2010. Though fundamentals weren't too impressive in 2011, things should look much better in the coming year. The company's biggest refineries -- the El Paso and Gallup refineries -- should pick up refining production once again.

And yes, the stock is cheap. Current P/E has fallen drastically, including the returns in the past six months. Additionally, January has once again seen the Brent-WTI spread rise following rebalancing of annual contracts, as well as investors fearing a shortage in Brent supply.

Stock No. 2: HollyFrontier
Though it's not a strict mid-continent operator, HollyFrontier's trailing P/E is way below its average P/E. This stock is dirt cheap. Its 85,000-barrels-per-day Tulsa refinery, acquired in 2009, has been producing results right away. But the market doesn't seem to have noticed. Holly's merger with Frontier Oil has ensured access to the 135,000 bpd refinery located in El Dorado, Kan. -- again a move that hasn't been noticed.

Stock No. 3: Marathon Petroleum
The spinoff from Marathon Oil says it all. The company has already been taking advantage of the WTI-Louisiana spread. Marathon's forte lies in the fact that all of its six refineries are in the Gulf Coast and Midwest regions. That, I believe, is good enough. Improving fundamentals are only a matter of time for the newly formed spinoff. And it's cheap.

I'm not too bullish on Valero simply because most of its refineries are located on the East Coast, which has a much higher exposure to the Brent variant. Hence, despite its stock having fallen considerably, the underlying fundamentals with regard to pricing aren't too impressive.

I believe these three refining stocks are the ones to look out for this year. But if you're looking for more ideas, The Motley Fool has created a special oil report titled "3 Stocks for $100 Oil," which you can download today, absolutely free. In this report, Fool analysts cover three outstanding oil companies. To get instant access to the names of the three oil stocks, click here -- it's free.

 Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. The Motley Fool owns shares of Western Refining. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (8) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 12, 2012, at 1:10 PM, 94Ag wrote:

    Isaac,

    Valero has ZERO refineries are on the East Coast.

    It has 1 in the UK, 1 in Canada, 1 in the Carribbean. ALL the other refineries are in the Gulf Coast,Mid-Continent, or West Coast.

    Motley Fool should hold it's writers to higher standards (or at least getting the facts right).

  • Report this Comment On January 12, 2012, at 2:41 PM, CanadaDreamer wrote:

    Buy refiners? You are out of your gourd. Just look at what Chevron warned about yesterday - horrific refining margins that have collapsed since Q3 - why? Because of exactly what you mentioned - the big rise in WTI and the narrowing of spreads.

    Read the Fool at your peril...

  • Report this Comment On January 12, 2012, at 6:02 PM, rgon1969 wrote:

    This is what makes the Fool work... vetting by others. Of course, it would be best if every author knew everything there is to know about their subject. However, that is unlikely to occur. "Read the Fool at your peril...." could also be stated as, "Do your due diligence and listen to more than one source."

  • Report this Comment On January 12, 2012, at 8:20 PM, JayBob100 wrote:

    Valero refineries are primarily in the midwest and center Gulf. However they do have refineries in Aruba, B\Great Britan and eastern Canada per their web site. Hence some exposure to Brent priced crude.

  • Report this Comment On January 13, 2012, at 9:41 AM, gimponthego wrote:

    Hometown boys and girls have always paid off in the long run. Living in the Alamo City, one has some Valero and Tesoro to cover the refining bases , gas station and "qik stop type" stores, always strategically placed. Their pluses outweigh their minuses over the long haul.

  • Report this Comment On January 13, 2012, at 1:03 PM, phrendly wrote:

    Why does Brent demand a higher price than WTI? Is it possible that Brent is more valuable, that its composition is such that it contains more higher value products? We have to know the relative value of Brent versus WTI before we can accurately assess the value of refiners that use more WTI in their process.

  • Report this Comment On January 24, 2012, at 5:47 AM, thidmark wrote:
  • Report this Comment On June 11, 2013, at 4:35 PM, XMFCinco wrote:

    Just stumbled upon this while doing some refiner research...

    How about giving credit where credit is due? Isac completely nailed this one with the WTI refiners. Ok, maybe he should have included Valero but a rising tide lifts all boats.

    Here's a chart of his 5 refiners vs. the S&P500 since the writing of this article:

    http://finance.yahoo.com/echarts?s=WNR+Interactive#symbol=wn...

    To phrendly's point, my understanding is that WTI is slightly "sweeter" than Brent, which means its actually slightly easier/cheaper to refine and has historically (before 2010) been priced at a slight premium: http://www.futuresmag.com/2013/05/13/wti-brent-crude-moving-....

    http://nesteoil.com/default.asp?path=1,41,538,2035,5196,5197...

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1757123, ~/Articles/ArticleHandler.aspx, 9/1/2014 3:12:29 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement