Refining Stocks Are Shaping Up to Have a Strong 2013
RJ is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
A number of refiners recently reported strong results in their respective fourth quarters. We at Valuentum have been watching the group’s tremendous performance via Phillips 66, a holding in Valuentum's Dividend Growth portfolio, but let’s dig into the firm’s peers to highlight a few industry trends.
On Tuesday, Valero (NYSE: VLO) announced a “blowout” fourth quarter, with earnings growing to $1.82 from $0.08 per share, trouncing the consensus estimate. Revenue was roughly flat, so what drove such substantial earnings growth?
CEO Bill Klesse said it best:
"Also in the fourth quarter of 2012, we replaced all imported light foreign crude oils with cheaper domestic crude oils at our Gulf Coast and Memphis refineries. Since we expect U.S. and Canadian crude oils to become increasingly more available, we are pursuing options to process additional volumes of these cost-advantaged crudes throughout our refining system."
Essentially, substituting crude from foreign producers to crude from domestic shale sources has given the domestic refiners a real cost advantage that didn’t exist previously. Even retail, a business Valero plans to exit, saw a 14% jump in operating income. Since the US shale revolution looks to have staying power, we think the cost structure of Valero’s business may be permanently lower.
Not to be confused with the other Marathon, Marathon Petroleum (NYSE: MPC) announced today that it swung from a loss of $0.21 per share to a profit of $2.26 per share in its fourth quarter, smashing consensus estimates. Although the company plans significant capital investment in 2013, it managed to expand its share repurchase program to $2.65 billion — on top of $1.35 billion worth of buybacks in 2012.
MPLX, an MLP established by Marathon and now trading on the New York Stock Exchange, will be Marathon’s main avenue to generate earnings in the midstream segment.
What’s driving profitability? Much like Valero and Phillips 66 (NYSE: PSX), Marathon has managed to find lower crude inputs, which has resulted in substantial refined-product margin expansion. Here’s what the company had to say about refining and marketing margins:
“The refining and marketing gross margin averaged $9.17 per barrel and $10.45 per barrel for the fourth quarter of 2012 and full-year 2012, respectively, compared with $0.39 per barrel and $7.75 per barrel for the fourth quarter of 2011 and full-year 2011, respectively.”
Again, we see a lower cost structure going forward. Though shares have doubled over the past year, we believe the company looks fairly valued at current levels.
Hess (NYSE: HES) is getting out of the refining business at precisely the wrong time. The business had been challenged for the past few years, but improvements in its cost structure made it profitable once again. Still, Hess will focus on its retail and marketing segment, as well as exploration and production to drive earnings. Production jumped 8% during the quarter to 396,000 barrels per day, with Bakken shale production up 68% year-over-year to 64,000 barrels per day.
The strategy was successful in its fourth-quarter report, released today, as the company swung to a profit of $1.66 per share from a loss of $0.39 per share, crushing estimates. Unfortunately for Hess, lower average selling prices will damage E&P earnings, even if production continues to rise. Hess’ balance sheet is highly leveraged, with net debt of nearly $7.5 billion. We aren’t nearly interested in the firm as we are in its refinery counterparts, and we think shares look fairly valued at this time.
Adjusted earnings per share jumped over 240% year-over-year to $2.06, smashing consensus estimates. Earnings for the year jumped 50% to $8.46, highlighting the considerable operating leverage inherent to the refinery business. Shares are now up over 90% since being spun off from ConocoPhillips in 2012.
Cash flow generation was superb, as the firm raked in $1.3 billion in operating cash flow. $1 billion was used to reduce debt, leaving the firm with a debt/capital ratio of 25%. The firm also added $1 billion to its share repurchase program, and hiked its dividend 25% (it raised it to $1.25 per share for 2013) -- though that figure represents a yield of less than 2% thanks to share appreciation during the past year. We love the firm’s aggressive capital management policies, which have helped the company quickly reduce debt while providing strong returns of capital to shareholders.
Phillips 66 benefitted tremendously from crude as a percentage of the mix (67% versus 57%), and shale oil processing, where barrels per day increased 97% from the same period a year ago. Refining and marketing earnings, adjusted for a large impairment in the company’s Melaka Refinery, jumped 18% year-over-year to $1.1 billion, even though utilization was 300 basis points lower at 91%. Export volumes also helped boost earnings, jumping 5% compared to the prior year. Even while crack spreads declined 33% sequentially, refinery market capture increased to 95% (was 79%).
Midstream earnings weren’t as strong, falling nearly 50% to $62 million on an adjusted basis. Lower natural gas prices weighed on earnings, and with a relatively warm winter and increasing supplies, we doubt the midstream segment will see a quick turnaround in profitability.
Chemical earnings surged over 150% to $246 million, as segment margins improved. Olefins and polymers volumes increased 8% year-over-year, and the company remains exposed to a favorable chemical mix.
While the company doesn’t give specific financial guidance for 2013, we think the year features some strong fundamental catalysts. Phillips 66 will add additional refining export capacity, and it expects to refine 200,000 barrels per day of shale oil during 2013, well above its current run-rate of 112,000 barrels per day. We also expect the firm to file for a master limited partnership, which should hit the market in the second half of 2013.
All things considered, we like recent trends out of the refining sector, giving us confidence in Valuentum's Dividend Growth Newsletter portfolio holding, Phillips 66. However, with shares of the firm nearly doubling in less than a year, we may exercise prudence and take a little off of the table in the coming weeks.
Valuentum holds shares of Phillips 66 in the portfolio of its Dividend Growth Newsletter. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!