Please ensure Javascript is enabled for purposes of website accessibility

Changing Industry Fundamentals Make These 2 Refiners Look Attractive

By Rupert Hargreaves – Mar 31, 2014 at 4:00AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

As crude spreads widen again, HollyFrontier and Valero Energy look attractive because of the locations of their refineries.

It's no secret that refiners had a slow 2013. After a profitable 2012 when the spread between the international Brent oil benchmark and the U.S. WTI oil benchmark -- a key metric for refining profitability -- widened to historic levels, the spread collapsed during 2013, squeezing profits. However, now refiners such as HollyFrontier (HFC), Valero Energy (VLO -0.86%), and Philips 66 (PSX 0.20%) are primed to make comebacks as several key benchmark spreads widen again.

Widening spreads
Analysts at Barclays have forecast that the spread between Brent and Light Louisiana Sweet, or LLS -- a benchmark that is rapidly taking the place of WTI as a reflection of market economics on the Gulf Coast -- will widen over the next year or so. The spread between Brent and LLS has closed in recent months because bad weather affected supply chains. However, now that the weather has cleared, analysts expect the Brent-LLS spread to widen throughout the rest of the year, and the refinery industry should benefit .

To play this trend the best refiner would be Valero Energy, as seven of the company's 14 refineries are located along the Gulf Coast.

However, HollyFrontier also looks well-placed to profit during the next few months. While the Brent-LLS spread is widening, the Brent-WTI spread has also expanded in recent weeks, although the spread is still far from the highs seen at the beginning of this year. The Brent-WTI has widened to $8.50 during the past week, off the yearly low of $6.10 it hit at the beginning of March. What's more, HollyFrontier has easy access to oil from the Permian Basin, which can trade at a discount of up to $8 from the WTI benchmark. So, for some of HollyFrontier's operations the spread between brought-in oil and refined product could be as wide as $16.8.  

So, it would appear that both HollyFrontier and Valero are well-placed to profit throughout the rest of the year, but which company is the best investment? Well, HollyFrontier has outperformed its larger peers on several key metrics during the past five or so years.

Impressive metrics
For a quick way of seeing how much more efficient HollyFrontier has been at generating returns than its larger peers have been, we can use the return on invested capital, or ROIC, metric. As defined by Investopedia, ROIC is:

A calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. The return on invested capital measure gives a sense of how well a company is using its money to generate returns.

Over the past five years, HollyFrontier achieved an average return on invested capital of 14.7%. In comparison, Phillips 66 only achieved an average ROIC of 9.9%. Valero, the country's second-largest refiner by market capitalization, has only been able to achieve an abysmal ROIC of 1% during the past five years.

Further, HollyFrontier has been able to draw a wider profit margin from every barrel of oil that the company has refined -- 22% higher to be exact. During the past five years, HollyFrontier's average net income per barrel has been $4.57, Phillips 66's has been $2.5, and Valero Energy has only been able to achieve a five-year average of $0.34.

How has this reflected on performance?
For investors, these impressive production and ROIC metrics are all well and good, but unless this feeds through into share price performance there is very little to get excited about. However, aside from HollyFrontier's lackluster stock 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, which is around 21% of the company's market capitalization. These cash returns have been achieved and supported while the company has kept its balance sheet clean -- its total debt-to-capital ratio was only .03 at the end of the third quarter of last year. Since the end of 2010, Valero has returned $2 billion to investors.

Bottom line
So overall, with both the WTI-Brent and LLS-Brent spreads widening it would appear that refiners are set for a profitable 2014. The best way to play this could be with HollyFrontier as the company is America's most efficient and profitable refiner. Still, if you're bullish on the Gulf Coast then Valero could be the refiner of choice.

Rupert Hargreaves owns shares of HollyFrontier.. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.