Wall Street has been incredibly kind to oil refiner HollyFrontier's (NYSE:HFC) stock over the past year: Its shares are up more than 120%. Those gains were in large measure a result of conditions in the refining market going from a severe low point in 2016 to incredible highs over the past couple of quarters. With that higher stock price came higher expectations, though, and the stock price drop that followed HollyFrontier's second-quarter earnings releasing occurred largely because it didn't meet them.
Let's take a look at the oil refiner's most recent earnings results, review what management is thinking about the industry today, and consider what these results mean for investors.
By the numbers
|Metric||Q2 2018||Q1 2018||Q2 2017|
|Revenue||$4.47 billion||$4.13 billion||$3.45 billion|
|Operating income||$506.9 million||$395.8 million||$120.8 million|
|Net income||$362.9 million||$268.1 million||$57.8 million|
HollyFrontier's Q2 results weren't quite as good as they appear at first glance. The company benefited from a valuation adjustment for its inventories, and a regulatory waiver for one of its smaller refineries. Adjusting for one-time gains and losses, earnings per share were $1.45 for the second quarter. On its own, that would be a respectable result, but it did miss Wall Street expectations after HollyFrontier's peers raised the bar for the quarter with fantastic results.
The driving force for HollyFrontier was, unsurprisingly, its refining segment. Refining margins have been lucrative during the past several months, thanks to infrastructure constraints that led to significant regional price discrepancies for crude oil. In Q2, Holly's refining margin was $16.57 per barrel.
Overall, the company's operations were solid. Its facilities ran at 101% of nameplate capacity for the quarter, and it increased its use of heavily discounted crude oil grades such as sour and heavy sour. The one thing that hurt the company was higher-than-usual operating expenses, which it attributed to a fire at its Woods Cross refinery that shut down much of its operating capacity. Woods Cross is a relatively small refinery, though, and the company was able to make up for its loss by running its other facilities a well above nameplate capacity.
What management had to say
HollyFrontier hasn't been afraid to make acquisitions from time to time, and management has proven effective at creating value from M&A. On the conference call, one analyst noted that the company was carrying much more cash on the balance sheet than usual, and was curious if all that additional cash was for a potential acquisition in the future. Here's CEO George Damiris' response:
I think we're seeing deals along the entire spectrum of size, our preference would be to do larger deals, I think, in the $0.5 billion range. [A] small deal takes almost as much time and effort as a bigger deal, but at the end of day it all comes down to how attractive we feel the opportunity is. We're seeing a lot of deals, as I mentioned, in my previous response. So, we're keeping a little more dry powder in reserve in expectation that some of these deals that we're seeing and working on will come to fruition, but again there is no guarantees that they will. And if they do again, we'll use the cash on the deal. If they don't hit, we'll return it to shareholders.
Expectations (and prices) high right now
Refining margins have been incredibly high lately, and that's done wonders for the bottom lines of HollyFrontier and its peers. Earnings miss aside, there wasn't a whole lot to dislike in this report. The repairs at its Woods Cross facility are complete, and management expects it to be back up to running at full nameplate capacity in September, so as long as refining margins hold, we can assume that next quarter's results should be a slight improvement from the previous one.
The refining industry has been going through quite a bit of consolidation lately, which means that assets for sale are going for high prices. It wouldn't be surprising if HollyFrontier made an acquisition since it has the financial muscle to make one, and management is on the prowl. That said, it would make more sense for them to sit on a cash pile and wait for things to go on sale further down the road.
That advice could be wise for investors to follow, too. Even though HollyFrontier’s P/E ratio is in the neighborhood of 10 -- which sounds cheap -- the environment in the refining market is working strongly in HollyFrontier’s favor right now. Refining margins rarely stay this good for long in this cyclical industry, and when they contract, it will significantly reduce earnings, at which point today's low P/E ratio will start getting larger and less attractive. For that reason, this is actually looking like a relatively expensive time to invest in HollyFrontier.