Are Refiners Going to Make a Comeback?

It is fair to say that refiners have not had an easy ride over the first half of this year. Unrest in the Middle East has put pressure on the WTI-Brent spread, which is a key metric of profitability for refiners. This has quashed profit margins and sent stock prices downward. However, things could be starting to look up as the prospect of military action in Syria gets further and further away, and the WTI-Brent spread starts to open up again, paving the way for larger refinery profits.

While this is good news for refiners such as HollyFrontier  (NYSE: HFC  ) and Western Refining (NYSE: WNR  ) , it is not good news for Northern Tier Energy  (NYSE: NTI  ) , which has been hit by a fire at its only refinery. That said, this fire has been somewhat of a blessing in disguise for Northern Tier.

Fire
The fire occurred on the Sept. 22 and was extinguished the same day. Damage was minimal considering what could have been. Initial estimates state that repairs will cost $10 million and last for three to four weeks. However, only the large crude distillation unit was damaged, the small distillation unit and downstream units of the plant were untouched and should be up and running again as I write. The loss of Northern Tier's large crude distillation unit will obviously affect production.

However, this has allowed to company to get on with some maintenance on its fluid catalytic cracking (FCC) unit, which was scheduled to begin at the beginning of October, but was brought forward by seven days. What's more, the fire has not dented overall production too much. Management has revised down production estimates from 90,000-95,000 barrels per day to 78,000-81,000 barrels per day. These production numbers are still above the sales volumes of 68,000 barrels per day reported during the second quarter of this year .

So, all in all the recent pullback in Northern Tier's unit price could offer an attractive entry point.

Fighting the shorts
Meanwhile, Western should be able to use the expanding WTI-Brent spread to continue its fight against short-sellers.

With 36% of its free-float short, Western makes it into the list of the most shorted companies in the S&P 500. However, management's recent approval of an additional $200 million commitment to the company's existing $200 million share repurchase program should start to scare the shorts.

Western is heavily dependent on WTI crude and cannot switch to heavier, cheaper crude oil from Canada and other regions, which has become popular among refiners during the past year as the WTI-Brent spread has collapsed. That said, Western has not suffered as much as its peer HollyFrontier. Indeed, year on year Western's net income has declined 37% while HollyFrontier's net income has declined nearly 50%.

Having said all of that, HollyFrontier has its own strengths and these come in the form of the company's fortress balance sheet.

Fortress balance sheet
HollyFrontier's total debt reached a high of $1.35 billion during the third quarter of 2012. Since then, debt has fallen to only $990 million, but cash and short term investments are worth just under $2 billion, so HollyFrontier is sitting on a net cash position. Actually, at the end of the company's fiscal second quarter, cash was equivalent to around $5 per share, 12% of HollyFrontier's current stock price.

It's this fiscal strength that gives me confidence in HollyFrontier's long-term outlook. Furthermore, the company's net cash position indicates that HollyFrontier can buy up growth by acquiring peers. Additionally, the firm can continue to issue a solid dividend as debt repayments are low and the company has plenty of free cash to buy back stock if pushed to increase shareholder returns.

Foolish summary
Refiners have not had a very good year so far but with the WTI-Brent spread starting to open up again and outlooks improving, it could be time to consider the sector again. Indeed, the WTI-Brent is reaching a level not seen since June this year, which indicates that refiners will have a good fourth quarter. In my opinion, these three companies are the best way to play this recovery.

 

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