A Refined Look at Refineries

 | May 02, 2014 | 9:00 AM EDT  | Comments
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Stock quotes in this article:

vlo

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mpc

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tso

The oil refining industry is tough. Prices for both crude oil and refined products are largely out of the refiners' hands. For years, refiners have seen profit margins squeezed as prices have moved against them.

But more recently, refinery profits expanded as increased domestic oil production lowered the crude feed price refiners paid. And there has been an increased spread between the price of domestic crude relative to the international price. The bottom line for refiners is, well, their bottom lines improved.

Not all signs are strong for the refining industry. Gasoline demand is weak as the economy is still trying to recover from the Great Recession. At the same time, hybrids and other high MPG vehicles are increasingly making up more of the nation's car fleet depressing demand. Plus, overseas refining capacity has increased.

Zach's recent look at the refining industry concluded: "We are more optimistic on the industry than we were a few months ago. After going through a bumpy ride for much of 2013, the sector has started to look up -- and it's mainly to do with the 'oil spread,' the difference between the WTI [West Texas Intermediate] price and its global counterpart, Brent."

My Peter Lynch-based strategy is also optimistic. Years ago, I computerized the strategies of some of Wall Street's most successful investors as they described them in their writings. One of these strategies is based on the thinking of Lynch, the great mutual fund manager.

The Lynch strategy gives strong recommendations to three companies whose business is, at least in part, oil refining: Valero (VLO), Marathon Petroleum (MPC) and Tesoro (TSO).

Valero's assets include 16 petroleum refineries, and about 7,400 outlets -- Valero, Diamond Shamrock and Beacon -- that carry its petroleum brands. Marathon is the fourth largest refiner in the country and the operates the nation's fourth-largest chain of company-owned and operated retail gasoline and convenience stores. Tesoro is a leading independent refiner and marketer that operates refineries in five states and has over 2,250 retail stations.

The P/E/G ratio (price-to-earnings relative to growth) is this strategy's most notable variable. This measures how much the investor is paying for growth at today's share price, and to earn the highest rating, the P/E/G cannot exceed 1.0. Valero's and Marathon's P/E/G ratios are both a very desirable 0.35, while Tesoro's is a perfectly acceptable 0.74. Valero's and Marathon's debt-to-equity ratios are a reasonable 33.7% and 31.1%, respectively, while Tesoro's is a less desirable 65.8%.

Refining is on the upswing, and this could be a good time to place a bet on refiners. These three companies are solid performers with strong recommendations from my Lynch-based strategy. If you want to fuel up your portfolio, stopping by any of these three stocks could do the trick.

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