These 4 Oil Refiners Are Still Cheap

Alvin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

HollyFrontier (NYSE: HFC), Tesoro (NYSE: TSO), Marathon Petroleum (NYSE: MPC), and Valero Energy (NYSE: VLO) are oil refining companies that have posted massive year to date gains. However, even after huge increases in their stock prices, the refiners are still cheap by many standards. The following table sums up the four companies.

<table> <tbody> <tr> <td> </td> <td>Year To Date Gain (%)</td> <td>Price ($)</td> <td>PE</td> <td>EPS (ttm $)</td> <td>Price To Tangible Book Value</td> <td>Tangible Book Value Per Share ($)</td> </tr> <tr> <td>HollyFrontier</td> <td>77.86</td> <td>41.62</td> <td>5.9</td> <td>7.09</td> <td>3.0</td> <td>13.87</td> </tr> <tr> <td>Tesoro</td> <td>76.37</td> <td>41.20</td> <td>8.9</td> <td>4.65</td> <td>1.5</td> <td>27.84</td> </tr> <tr> <td>Marathon Petroleum</td> <td>61.37</td> <td>53.72</td> <td>7.6</td> <td>7.04</td> <td>1.9</td> <td>27.65</td> </tr> <tr> <td>Valero</td> <td>51.88</td> <td>31.97</td> <td>11</td> <td>2.91</td> <td>1.1</td> <td>29.67</td> </tr> </tbody> </table>

Looking at the big gains in the stock prices, it is easy to jump to the conclusion that it is too late to buy these stocks. However, it is important to keep in mind that stocks represent ownership of an underlying business. Thus, there are times that even after a massive rise of over 50% a stock is still undervalued. It is how multibaggers happen.

Two ratios that are commonly used in valuation are PE and Price To Tangible Book Value (PTBV). A low PE, below 10, for a good company usually means it is undervalued. A PTBV of less than one means a stock is selling for less than its equity. As shown, HollyFrontier, Tesoro, and Marathon Petroleum have trailing PEs that are below 10. Valero has a trailing PE of 11, but the company is only trading at a PTBV of 1.1. Similarly, HollyFrontier has a PTBV of 3, but its PE is only 5.9. Out of these four companies, HollyFrontier and Valero are probably the best investments because HollyFrontier has the lowest PE and Valero has the lowest PTBV.

Looking at the refining business over all, it is a low margin business. According to Yahoo! Finance, the Oil & Gas Refining & Marketing Industry has an average net profit margin of 3% (most recent quarter). It is very low margin. However, the industry has high barriers of entry, is essential, and can quickly pass costs onto consumers. Thus, profitability can be maintained.

Additionally, due to a number of factors (i.e. slow economy and price fluctuations of crude oil), oil refiners have recently had erratic earnings. The following table shows average earnings per share in the last five years for each company.

<table> <tbody> <tr> <td> </td> <td>HollyFrontier</td> <td>Tesoro</td> <td>Marathon Petroleum</td> <td>Valero</td> </tr> <tr> <td>5 Year Avg EPS ($)</td> <td>2.34</td> <td>1.77</td> <td>3.89</td> <td>2.08</td> </tr> </tbody> </table>

As shown, the numbers are significantly less than the trailing twelve months EPS’s. However, the five year averages include the worst year, 2009, of the global financial crisis. Presently, the global economy is struggling. However, earnings will likely remain high because US refineries are benefiting from the rise in US oil production (e.g. Bakken crude oil). Additionally, WTI crude is priced $19 less than Brent Crude. According to the US Energy Information Adminsitration (EIA), the discount is due to transportation bottlenecks. While it is highly unlikely that such a wide spread will last, it is beneficial to US refineries and will boost profits.

The last things to consider are the potential purchases of BP’s (NYSE: BP) refineries. BP agreed to sell its 266,000 bpd refinery and related assets to Tesoro for $2.5 billion. Additionally, BP is reportedly in talks with Marathon Petroleum about purchasing BP’s 400,780 bpd Texas City refinery (Fox). If these purchases happen, Tesoro’s and Marathon Petroleum’s refining capacities will rise by 39% and 34%, respectively. This should theoretically boost the companies’ values by the same percentages.

In summary, even after their massive increases in stock prices, these refining companies are still cheap. HollyFrontier, Tesoro, and Marathon Petroleum have PE ratios of less than 10. Valero has a PE of 11, but the stock is only priced at $2.30 above its tangible book value per share and has a dividend yield of 2.2%. Additionally, US oil refineries are benefitting from rising US oil production. Overall, these companies are still cheap.

Alvin owns shares of Valero Energy. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend HollyFrontier. Try any of our Foolish newsletter services free for 30 days. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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