Is Western Refining Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Western Refining (WNR) fit the bill? Let's look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Western's story, and we'll be grading the quality of that story in several ways:

• Growth: Are profits, margins, and free cash flow all increasing?
• Valuation: Is share price growing in line with earnings per share?
• Opportunities: Is return on equity increasing while debt to equity declines?
• Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's look at Western's key statistics:

WNR Total Return Price data by YCharts

Source: YCharts.
*Period begins at end of Q2 2010.

WNR Return on Equity data by YCharts

Source: YCharts.
*Period begins at end of Q2 2010.

How we got here and where we're going
Western Refining kicked things off with a strong performance, but its mediocre revenue growth presented the only real obstacle to a better score than six out of nine passing grades. One of Western's falling grades only happened because net income growth has surpassed the growth of free cash flow during our tracked period -- however, Western's nominal free cash flow is actually higher than its net income. These gains have driven Western's shares to a strong three-year performance, but even so, its value is barely half of share prices before the financial crisis. How might Western Refining push its revenue even higher over the next few quarters? Let's see what's in store.

Over the past few months, crude oil refiners have been struggling to maintain their profitability due to  a compression in the price differential between the two most popular crude oil benchmarks, the internationally traded Brent and the domestic West Texas Intermediate, or WTI. Fool contributor Isac Simon notes that the WTI's $20 per barrel discount against Brent crude has been wiped out as the efficient outflow of crude oil to Gulf Coast refineries from the Cushing hub increased the availability of domestic crude oil. Consequently, Western's net income fell 33.86% to $126.8 million.

This isn't even the worst performance among domestic refiners: The nation's fourth-largest refiner, Marathon Petroleum (MPC -1.30%), recently posted a quarterly net income of $593 million, down 58% from its year-ago quarter. Fool contributor Dan Caplinger notes that Western is exposed to more risk than its larger rivals because it largely relies on sales in the domestic gasoline and refined-products market. In addition, the new EPA regulation for renewable fuel credits will squeeze the profitability of small refiners, as it demands blending renewable fuels into marketable gasoline.

However, Western should enjoy excellent tax benefits from its upcoming master limited partnership, or MLP, spinoff. My Foolish colleague Aimee Duffy notes that the company's pipeline and storage MLP, Western Refining Logistics (NYSE: WNRL), recently raised about $287.5 million by issuing 12.5 million shares -- the new spinoff began trading just this past week and is already enjoying heightened investor interest thanks to its less-volatile focus on midstream operations. Industry peer Marathon has already seen huge success from the spinoff of its midstream business into MPLX, which is currently leveraging opportunities in the Utica, Marcellus and Illinois Basin.

Putting the pieces together
Today, Western Refining has many of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.