Two Overlooked Refiners

 | Feb 05, 2013 | 10:00 AM EST
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The refining sector has followed up its stellar performance in 2012 with an extremely strong start in 2013. Sector heavyweights Valero (VLO) and Phillips 66 (PSX), which I have recommended several times over the last nine months, are both up better than 15% in the past month. The sector is experiencing positive tailwinds via growing domestic and Canadian oil production (which is lowering feedstock costs). Because no major refinery has been built in the U.S. since the 1970s, these companies have higher than average historical crack spreads (the profit refiners make by turning crude into petroleum products) and wide margins, which enrich to the bottom line.

I am hesitant to add to my positions in the major refiners given their recent huge run. But I am looking at smaller refiners that look like good buys on any kind of market pullback over the next few weeks.

I have my eye on two smaller refiner stocks. Both are cheap and benefit from the same tailwinds as the majors. In addition, they could make sense as buyout targets given their relatively small market capitalizations because it is probably cheaper and easier to buy refinery capacity than to build it, given current environmental regulations. Both refiners could benefit by moving to a master limited partnership structure, which would allow them to offer high yields and further unlock the value of their refinery assets (The second company profiled actually spun off a subsidiary under this structure recently). Calumet Specialty Product Partners (CLMT) has been very successful with this structure in this space.

PBF Energy (PBF) operates as a refiner and supplier of petroleum products. It has a couple of refineries on the East Coast that can process heavy crude. Its operation in Toledo, Ohio, is ideally positioned to process the light sweet crude coming from the Bakken, Utica and Canadian shale regions. The company went public in December.

Four reasons PBF can go higher from $33 a share:

  • It just completed a rail facility that will allow up to another 70,000 barrels per day to be carried from the Bakken shale region to its refinery in Delaware City, Del. Analysts believe revenue at the company will rise more than 45% in 2013.
  • PBF shares trade at the second-lowest EV/EBITDA multiple within the refiner group.
  • The stock is cheap at just over 6.5x forward earnings.
  • The stock will yield approximately 2.5% at current prices (less than 20% payout ratio). As infrastructure projects are completed and bringing additional feedstock to its refining facilities, I anticipate the payout ratio and dividend payouts increasingly substantially.

Delek U.S. Holdings (DK) operates refining assets, approximately 400 miles of pipeline, and about 380 retail fuel and convenience store outlets.

Four reasons DK has value at $34 a share:

  • Consensus earnings estimates for 2013 have increased by more than 20% in the past three months.
  • Credit Suisse raised its price target to $43 from $36 in early February on improved margins as the company switches more feedstock to cheaper domestic and Canadian oil, which is not reflected in the current share price.
  • The company has significantly beat earnings estimates in each of the past three quarters. Its shares are priced at less than 9x forward earnings, a substantial discount to its five-year average (21.6).
  • Although revenues will go down in 2013 due to its recent spin off of Delek Logistics Partners (DKL), the stock sports a five-year projected PEG below 1 (0.89).

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volatility is quite low here, and we could see some downsides here in the short term. ...



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