Refiners have been some of the worst performing stocks on the market in recent months as investors have turned their backs on the company's, citing concerns about pending emission regulations, and the shrinking Brent-WTI spread, a key indicator of refinery profits. In addition, these falls have been compounded by the gains made in the sector last year.
However, this sell-off could offer value investors the perfect opportunity.
HollyFrontier Looking Attractive as Value
After the recent declines, refiner HollyFrontier Corp (NYSE:HFC) looks like the perfect value investment. Indeed, HollyFrontier currently conforms to all of Benjamin Graham's value investing criteria set out in his book, The Intelligent Investor:
- The company's sales have exceeded $1 for the last five years
- At the end of 2012, current assets covered current liabilities nearly three times
- Current assets covered total debt twice
- The company has produced positive earnings for each of the last ten years
- The company has paid a dividend for each of the last twenty years
- Earnings have grown 616% during the last ten years
- Based on average earnings-per-share over the last three years the company trades at a historic P/E of 7.7
- HollyFrontier's assets are worth $29.4 per share, indicating a P/B ratio of 1.3
All of this adds up to a Graham Number of $71.37, which means that at its current price, HollyFrontier Corp (NYSE:HFC) looks like a good company, trading at a great price with a significant margin of safety for any prospective value investors.
Having said all of that, the reason for HollyFrontier's low valuation is because investors have fled the stock, fearing that new tougher emission regulations and a rapidly contracting Brent-WTI spread will clobber profits. However, some of these fears may be overdone.
In particular, the shrinking Brent-WTI spread may not wreak as much havoc at the company as many investors fear.
Indeed, like many refineries throughout the U.S., HollyFrontier Corp (NYSE:HFC) has been working throughout the last year to change the mixture of its feedstocks away from Cushing WTI and Brent, to advantage crude, or cheaper oil and oil blends from around North America, which are usually priced at the depots and not publicly traded. HollyFrontier adjusted its mix of feedstocks in the first quarter of this year, increasing the use of cheaper feedstocks and blends by 3%, which allowed the company to report higher profits despite lower utilization rates.
Furthermore, the price of Bakken crudes are starting to disconnect with WTI as the price of transportation drives down the amount that buyers are willing to pay.
Other Oil Benchmarks Retreating
Elsewhere, while the widely traded WTI benchmark is up by more than 13% since the end of the third quarter, other oil benchmarks are not undergoing the same kind of bullish momentum and have actually moved in the opposite direction over the same period:
- Group 3 ULSD - likely to actually be produced from WTI - down 1.1% since March 1
- Gulf Coast pipeline ULSD - down 2.5% since March 1
- LLS - down 2.5% since March 1
There are also signs in the futures market that this contraction in the Brent-WTI spread could be short-lived. WTI futures have recently moved into sharp backwardation, the contract for August delivery is currently trading at 102.99, while the contract for December delivery is trading at $99. In addition, current futures prices indicate the Brent-WTI spread widening back to $6 in December and then up to $7.5 in March 2014.
HollyFrontier - Sunny with High Clouds
So, all in all, HollyFrontier Corp (NYSE:HFC) looks like a good value investment opportunity with a good margin of safety priced into the company's current share price. Having said that, the company's outlook is cloudy and options remain mixed over the company's ability to continue to churn out profits while the Brent-WTI spread closes. Mind you, HollyFrontier has been profitable for the past ten years and during that time, from 2002 to 2006 and then from 2007 to 2009, the Brent-WTI spread was negative, which gives me confidence in the company's ability to maintain its growth, profitability and shareholder returns.
Disclosure, I own shares in HollyFrontier.