Over the past year, HollyFrontier (NYSE:HFC) has severely underperformed its larger peers, Phillips 66 (NYSE:PSX) and Valero Energy (NYSE:VLO). Specifically, excluding dividends, over the past year HollyFrontier's stock price has declined 18%, Phillips 66's has driven higher by 17%, and Valero Energy's share price has risen by 5%.
Ignore the share price
forgetting this short-term underperformance, investors shouldn't give up on HollyFrontier. Indeed, the company has many desirable qualities and appears to be well managed under the face of it all. For example, a quick look over the figures supplied by HollyFrontier shows that despite the company's lagging share price, the company appears to be outperforming its comparable peers on a business basis.
In particular, during the past five years, HollyFrontier achieved an average return on invested capital, or ROIC, of 14.7%, the highest of its peer group. Phillips 66 only achieved an average ROIC of 9.9% and Valero Energy's return has been, what can be described as an abysmal 1%. Part of this return can be attributed to HollyFrontier's strategically located refineries, which allow the company access to an advantaged crude slate.
Good locations, low cost
HollyFrontier's refineries, as shown above, are located close to the Mississippi Lime, Permian/Eagle Ford Basins, and Uinta/Niobrara formations, all of which are expected to report strong production growth over the next few years. In addition, HollyFrontier is the general partner of Holly Energy Partners, which owns several pipelines and storage facilities connecting these major production zones.
All in all, these strategically located refineries mean that the company has access to oils that trade at a discount to Brent and WTI, allowing better profit margins. Once again, according to numbers supplied by the company, HollyFrontier's net income per barrel of crude refined has been 22% higher than its closest comparable peer. Specifically, on average, during the past five years, HollyFrontier's average net income per barrel has been $4.57, Phillips 66's has only been $2.5, and Valero Energy has only been able to achieve a five-year average of $0.34.
How is this reflecting on performance?
For investors, these impressive production and return-on-capital metrics are all well and good, but unless this feeds through to investment performance, then there is very little to get excited about. However, aside from HollyFrontier's lackluster share price performance, the company has been returning impressive amounts of cash to investors. Since July 2011, HollyFrontier has returned around $1.9 billion in cash to investors, around 21% of the company's market capitalization. These cash returns have been achieved and supported while keeping the balance sheet clean -- total debt to capital was only 3% at the end of the third quarter last year.
Looking for bolt-on growth
What's more, HollyFrontier is targeting growth, and the company's management is seeking acquisitions at the right price, which will ultimately limit the prospect of mistakes occurring and waste of shareholder equity on what could prove to be fruitless acquisitions.
Specifically, HollyFrontier's management is on the lookout for acquisitions that produce a return of at least 2x the cost of capital. In other words, if the company borrows $1 billion to make an acquisition and this costs 5.5% per annum, HollyFrontier's management will want an annualized return of 11% from the acquisition in order to make the deal. Aside from this strict criteria, HollyFrontier's management is also looking for assets with existing supply/off-take agreements to de-risk income and cash flows. All in all, this would appear to be an extremely well thought out and planned acquisition strategy.
Having said all of that, HollyFrontier is still a risky businesses, and the company is still somewhat dependent on crude prices and economic headwinds. It would appear that the company's management is working hard to reduce these downside risks however.
All in all, investors should not judge HollyFrontier on its share price performance alone. The company's strategically located refineries give it an advantage over its peers as can be see with the high return on capital. Further, investors are reaping the benefits through cash distributions, and this should be set to continue.