U.S. Refiners enjoyed a profitable run during 2011–2012. Pipeline bottlenecks forced the price of West Texas Intermediate crude well below the price of Brent crude. This led to enviable spreads between the price of crude and the prices of refined products. As the bottlenecks resolved, West Texas Intermediate rose in price, spreads dropped and refinery earnings went with them.
Enviable spreads may be returning. Light sweet oil production in the U.S. threatens to exceed refinery capacity. Since the U.S. cannot export crude oil by law, this excess of crude oil could cause prices to drop. . Improved rail and barge transport of oil to East Coast refiners should displace more expensive African light sweet crude. Let's look at three refiners that should benefit from declining crude oil prices.
Big is beautiful
With an enterprise value of $37.1 billion, Phillips 66 (PSX +0.18%) clearly is the biggest of the three refiners reviewed here. The company is the product of the 2012 breakup of ConocoPhillips, which separated its midstream operations into Phillips 66 and its upstream operations into ConocoPhillips. Soon after its creation, Phillips 66 stock peaked at $70 a share only to more recently retreat to $59 a share. It currently pays a dividend of 2.6%
Even though recent quarterly earnings were below those of a year ago, Phillips announced a 25% increase in its dividend, continuation of a $3 billion stock buyback, and reduction of its debt. Perhaps more exciting for investors, Phillips 66 seeks to have its non-refinery operations contribute disproportionately more income in the coming years. The growth of natural gas liquids, petrochemicals, and crude oil transport all could drive future revenues for the company.
One bad quarter, a buying opportunity?
This past quarter, Calumet Specialty Products Partners (CLMT +0.00%) earnings disappointed, and the stock suffered accordingly. Specifically, the stock dropped from a recent high of $36 a share to less than $28 a share. The main culprit: a planned 45-day shutdown/turnaround of its Superior, Wisconsin refinery, the company's second largest. This was responsible for roughly $26 million in extra expense and represented roughly 40% of the net income decline from the previous year.
Despite this income drop, the company raised its distribution by half a cent, apologetically, and implied richer increases in the future. Calumet believes going forward, its increased crude oil expenses can be passed on to customers. If the price of West Texas Intermediate falls significantly, that's another boost to earnings.
What will drive future earnings? First, its Royal Purple division enjoys increasing revenues. Revenue gains should continue as Wal-Mart recently approved Royal Purple as a vendor. Second, Calumet recently announced the acquisition of midstream assets from Murphy Oil, which will allow Calumet to buy more oil directly from producers, thus reducing costs. In an email, the company would not quantify the impact of either the acquisition or the Wal-Mart deal but viewed each as "a clear positive for the business." Third, the Superior refinery is back online and will resume its earnings contributions.
A 22% dividend? For real?
Generous dividends appeal to investors, but when a company pays over 22%, one proceeds carefully. That dividend is high for a reason. In the case of Alon Energy Partners (NYSE: ALDW) I suspect the dividend is high because it's uncertain. The company was formed in 2012 as a spinoff of Alon Energy USA. The company operates one refinery in Big Springs, Texas and a network of wholesale and retail fuel businesses. To date, Alon Partners paid three quarterly dividends, ranging from $0.57 to $1.48 with no trend.
How does Alon make its money? It locates its refinery in the middle of the Permian Basin, favors cheaper sour oil produced in the Permian, and sells its refined fuels to physically integrated wholesale and retail businesses. Specifically, by using West Texas Sour, Alon currently saves over $5 a barrel in crude costs. This helped Alon generate $18.8 per barrel in free cash flow in the second quarter of 2013.
Perhaps the biggest threat to the dividend is the company's one refinery. Not that there's anything wrong with it, but refineries do need downtime for maintenance and as happened with Calumet, downtime means reduced earnings. When your company operates one refinery, the impact of maintenance is all the greater. Its wholesale and retail operations will soften the financial blow, but still, Alon hinges on its Big Springs refinery.
Final Foolish thoughts
Each of these companies has its appeal. Phillips 66 offers a modest but growing dividend and the safety of a large company. Alon offers a whopper dividend but the risk of relying on one refinery. Calumet offers a bigger dividend than Phillips 66, but more security than Alon. A mix of the three might prove best. As the chart below shows, 100 shares of each stock generates an average of $2.39 for an effective yield of 11.5%.
|
Company |
Dividend per share ($) |
Price per share ($) |
Yield (%) | |||
|---|---|---|---|---|---|---|
|
PSX |
1.59 |
59 |
2.7 | |||
|
CLMT |
2.74 |
28 |
9.8 | |||
|
ALDW |
2.84 |
12.81 |
22.2 | |||
|
Average |
2.39 |
33.27 |
11.5 |
Perhaps the best solution is to spread the risk around.
