This article is part of our Rising Star Portfolios series.
The two weeks since I made a second purchase of Western Refining (NYSE: WNR) shares for my Messed-Up Expectations portfolio have not been kind, either to that second purchase or most of the positions in the portfolio. But rather than letting the market put me into a funk about how badly the portfolio's done, I believe the market is giving me an opportunity to buy more of companies I believe are good investments at favorable prices.
The story for Western Refining hasn't changed. In fact, it's improved. In the article detailing my initial purchase, I pointed out how gross, operating, and net margins had turned around and were improving. For the trailing-12-month (TTM) period ending last March, the company had just turned bottom-line profitable and had enjoyed four sequential rolling periods of margin improvement.
After reporting second-quarter results last week, it has become even more profitable, improving TTM net margin a full 100 basis points, along with the other margins, as shown below.
Source: Capital IQ, a division of Standard & Poor's.
Part of the reason for this improvement has been the persistent spread in crude oil prices between Brent and Western Texas Intermediate (WTI). Western Refining buys the cheaper WTI oil, but sells its products at prices dependent on the more expensive Brent.
In contrast, Valero (NYSE: VLO), the largest independent domestic refiner, has TTM margins of 4.6% gross, 2.5% operating, and a meager 0.7% net, most likely a result of using both Brent-priced and WTI-priced oil. Western Refining doesn't use Brent-priced oil.
While other refiners also have that benefit -- CVR Energy (NYSE: CVI) and HollyFrontier (NYSE: HFC) -- and even have higher margins, the priced-in expectations for them are much higher than are currently priced in for Western Refining. In fact, the price of Western Refining had fallen so far last night that free cash flow is actually expected to significantly decline every year for the next 10 years, as much as 13% annually, then never grow again, even using an aggressive 15% discount rate. If Western Refining were expected to do no worse and no better than it has for the latest TTM period, the price would be nearly double what it is now.
It seems to me that the biggest worry weighing down Western Refining's price is that people will use less gasoline as they cut back because of the economy. Yet the company's average five-year free cash flow growth, including through the Great Recession, is actually positive, about 18% per year. Compared to that, the current expectation of negative FCF growth for 10 years seems messed up.
Tomorrow, I'll buy another 2% position of Western Refining for my Rising Star portfolio.
After you add Western Refining to your watchlist, come discuss the company and the refining industry at the MUE discussion board.
This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).
