And I mean, really feasting.
For investors, the continued overabundance in oil should keep prices relatively lower for at least a few years. That means the best days for refining stocks could be just right ahead. The time to buy the sector for the long term could be now.
Margins Getting Fatter
Firms operating in the downstream sector make money based on the difference between their crude oil costs versus what they can charge for refined products. For most refiners, oil inputs are priced in West Texas Intermediate (WTI) oil or Western Canadian Select (WCS). However, global gasoline pump prices, along with prices for other refined products, are generally based on the price of the European standard, Brent crude.
That difference is called the crack spread. It varies based on the exact inputs and what is produced, but with WTI/WCS imploding over the last few weeks, margins at refining firms are getting that much juicer. As WTI benchmarked oil prices recently touched a six-year low of only $42.03 per barrel, 3:2:1 crack spreads have grown to around $30 per barrel.
That metric was under $7 per barrel back in January. Basically, this means that refining stocks are going to be making more money turning oil into processed products than even just a few months ago.
And, it looks like the glut in crude oil isn’t going to end just yet.
For the week ending March 6th, the Energy Information Administration’s (EIA) latest crude commercial inventory showed that oil in storage across the U.S. increased by 4.5 million barrels to reach a total of 448.9 million barrels. This marks the ninth consecutive week of oil stock increases. Meanwhile, the EIA also recently updated its oil production estimates for the rest of year. While new drilling activity has declined significantly, wells already drilled are still pumping out plenty of crude, and the agency revised upward its previous estimates for the year. Globally, oil production continues to rise as well, and Saudi Arabia’s recent pledges to keep production humming along will keep that fact true for quite some time.
As if that wasn’t enough to help pad refining stock margins, players in the sector have recently taken it one step further by using logistics to their advantage. New crude-by-rail, crude-by-barge and even shipping oil via tanker truck has allowed refiners to take control of their supply chains and secure a more predictable — read: cheaper — stream of crude oil for their operations. That’s helping boost refining stocks’ bottom lines and take some of the variability out of their earnings, like in years past.
All in all, the recent rising crack spreads, huge supplies of crude oil and growing cash flows have meant one thing — the halcyon days are back for the refining stocks.
Two Refining Stocks To Buy
Valero Energy Corporation (NYSE:VLO): As America’s largest independent refiner, Valero should be given preference by investors looking to add a dose of downstream stocks to their portfolio. Across its 15 refineries throughout the United States, Canada and the Caribbean, VLO has refining capacity of 2.9 million barrels per day. That size allows VLO to take advantage of differences in crude oil pricing and increase its margins.
And, increase those margins it has. For all of 2014, VLO reported adjusted earnings of a whopping $6.68 per share — a 51.5% increase from 2013’s numbers. That gain was due to rising margins, cost controls and increased through-put. What’s crazy is that huge gain was during a period of much higher oil prices and lower crack spreads.
This also means that VLO’s current P/E of 9 and dividend yield of 2.7% are monster bargains going into the rest of 2015.
Western Refining, Inc. (NYSE:WNR): If Valero is one of the best large refining stocks to own, then Western Refining could be one of the best smaller downstream players to snag. WNR owns/operates two refineries — one in Texas and the other in New Mexico — that have a combined total capacity of 151,000 barrels per day. While that may seem like small potatoes when compared to VLO, WNR’s small size is a boon to the firm’s earnings and margins.
The key to that has to do with where WNR’s facilities are located. These refineries can take advantage of rising production and dirt cheap crude oil in the Permian Basin and Eagle Ford. That provides plenty of hefty margins for WNR. In its latest earnings release, Western reported a huge jump in gross refining margins — up from $7.99 to $22.13 per barrel. That led to nearly double the full year earnings in 2014, compared to 2013’s numbers.
WNR should see even better numbers during its first-quarter report. And like Valero, WNR is still one cheap refining stock. Western shares can be had for P/E of 8.73 and a dividend yield of 2.5%.
The Bottom Line: As crude oil has plunged, refining stocks have begun to feast. That should continue throughout the year as the sector is propelled by bullish catalysts. Both VLO and WNR make ideal candidates to buy.
Disclosure: Author is long VLO and the Vanguard Energy ETF (NYSE:VDE) — which holds both VLO & WNR
