3 Winners in the 1 Energy Sector to Buy Now

by Susan J. Aluise | August 2, 2012 8:00 am

3 Winners in the 1 Energy Sector to Buy Now

Forget crude oil, pass on natural gas — if you’re looking for energy stocks to power your portfolio right now, refineries could be your best bet. Slumping energy demand and falling oil prices have so dominated the headlines lately that they’ve obscured the recent boom in the refinery business.

Want proof? Just look at these three refiners that posted quarterly earnings this week: independent refiner Valero Energy (NYSE:VLO[1]), and two recent Big Oil spin-offs — Marathon Oil’s (NYSE:MRO[2]) Marathon Petroleum (NYSE:MPC[3]) and Conoco-Phillips‘ (NYSE:COP[4]) Phillips 66 (NYSE:PSX[5]).

Valero shares rose more than 6% on Tuesday after the company reported a nearly 12% rise in second-quarter earnings. VLO beat analysts’ estimates on the top and bottom lines, with profit of $1.50 a share on nearly $34.7 billion in revenue. Wall Street had expected $1.42 on $31.7 billion in revenue.

Phillips 66’s first quarter as an independent[6] entity started out with a bang on Wednesday: Second-quarter earnings rose 14% to $1.86 a share. Analysts had expected $1.78. But PSX’s revenue slipped 6.7% to $47.8 billion versus analyst forecasts of $54.6 billion.

A year after MRO spun off its refining unit, Marathon Petroleum is hitting its stride. Although second-quarter earnings of $2.53 a share released Tuesday missed analysts’ estimates by a penny, MPC beat on revenue with nearly $20.3 billion, rather than the expected $19.3 billion. Those results were despite a 7.4% drop in pipeline segment earnings.

That’s a pretty big turnaround in a very short time. The refining, also called “downstream,” business looked pretty grim earlier this year[7] when higher crude oil prices pressured refiners’ margins. Refineries make money on “crack spreads” — the difference between the price of crude oil and the gasoline, jet fuel and other petroleum products that are extracted from it.

Refining companies took a hit on higher oil prices combined with sluggish demand. Some companies responded by idling — or even selling off — refineries on the East Coast[8] that can process only the more expensive, imported Brent crude instead of the cheaper domestic West Texas Intermediate (WTI).

But a boost in oil production in America’s heartland has increased crude oil supply, enabling refiners to snap up the black gold at bargain prices. Oil prices have dropped by nearly 20% over the past quarter alone. That cheaper oil has boosted refinery margins and revived the U.S. downstream industry.

However, lower demand has also driven down gasoline prices[9] from their earlier 2012 highs, so that — as well as any potential near-term rise in crude oil pricing — bears watching. But if current trends continue, the refining sector will be the breakout energy performer for the second half of 2012. Here’s how these three winners stack up right now:

Phillips 66

I rank PSX No. 1 because as the newest large independent on the block[10], it’s moving fast. Phillips announced on Wednesday it will hang on to its Alliance refinery near New Orleans — it had said it planned to sell the facility last year. Instead, PSX will more than triple the plant’s export capacity to 220,000 barrels a day by next year.

Phillips 66 is experiencing strong margin growth in refining operations, and its high concentration of refineries in the Midwest positions it to reap considerable rewards as drilling increases in the region.

With a market cap of nearly $24.2 billion, PSX is trading at $38.27 — a gain of 35% since the spin-off. The stock rose nearly 2% on Wednesday’s earnings report. It has a price to earnings-growth (PEG) ratio of about 0.7, indicating the stock is undervalued. It’s forward P/E is less than 8. It also has a current dividend yield of 2.1%. Buy PSX with a target price of $41.

Marathon Petroleum

Despite the comparatively subdued earnings, I see a significant opportunity for MPC. The company’s Midwest and Canadian crude oil supplies are relatively inexpensive, and it, too, is boosting export capacity.

Earlier this year, MPC announced it would spin off its pipeline operations[11] into a master limited partnership (MLP), which will raise cash. Marathon Petroleum’s Speedway retail unit boosted cash flow during the quarter and continues to be a key contributor to MPC’s earnings and overall strategy.

With a market cap of $16.1 billion, MPC is trading around $46.80, almost 80% above its 52-week low last October. Even so, the stock has a tiny PEG ratio of 0.5 (indicating that it’s very undervalued). Its forward P/E is less than 7. A current dividend yield of nearly 3% doesn’t hurt either. Buy Marathon Petroleum with a target price of $54.

Valero Energy

I like a lot of things about VLO. It has a solid focus on cost control, it’s investing strategically in turnaround maintenance for key facilities and it’s sharpening its focus on its core business. Valero announced plans on Tuesday to divest its profitable 1,000-station retail unit, which should draw attention from several potential buyers — perhaps even MPC.

The largest independent U.S. refiner by processing capacity, VLO has a $15 billion market cap and at around $27, shares are trading 66% above their 52-week low last October. What I don’t like is the high PEG ratio of about 1.6, indicating that the stock is overvalued. On the upside, its forward P/E of a little over 6 is among the best in the sector. It also has a current dividend yield of 2.7%. Buy VLO with a target of $31.

Bottom Line: I’m bullish on all three of these stocks, if — and it’s a big if — demand remains steady and oil prices don’t spike. Refining is all about those margins, after all.

As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.

Endnotes:
  1. VLO: http://studio-5.financialcontent.com/investplace/quote?Symbol=VLO
  2. MRO: http://studio-5.financialcontent.com/investplace/quote?Symbol=MRO
  3. MPC: http://studio-5.financialcontent.com/investplace/quote?Symbol=MPC
  4. COP: http://studio-5.financialcontent.com/investplace/quote?Symbol=COP
  5. PSX: http://studio-5.financialcontent.com/investplace/quote?Symbol=PSX
  6. Phillips 66’s first quarter as an independent: http://investorplace.com/2012/07/did-conoco-cut-off-a-valuable-arm/
  7. looked pretty grim earlier this year: http://investorplace.com/2012/01/avoid-the-margin-squeezed-refiners/
  8. refineries on the East Coast: http://investorplace.com/2012/07/east-coast-drivers-catch-a-big-break/
  9. driven down gasoline prices: http://investorplace.com/2012/05/surprise-a-cooler-summer-for-pump-prices/
  10. newest large independent on the block: http://investorplace.com/2012/06/conoco-or-phillips-66-only-one-is-a-buy/
  11. spin off its pipeline operations: http://investorplace.com/2012/02/marathon-pipeline-spin-off-mpc/

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