For years, oil refiners were the one group of within oil stocks that wasn’t weighed down by the slump in global prices. However, in the past year, oil refiners have lagged as investors have become more cautious.
Bank of America recently upgraded its outlook for oil refiners and said investors no longer need to be defensive in the space. Analyst Doug Leggate says investors should focus on oil stocks that provide both value and cash flow.
Oil prices are wavering again on renewed trade war fears, but overall the sector seems to be trying for a recovery.
And if that happens in earnest, here are three oil stocks to buy to ride that tide.
Oils Stocks to Buy: Valero
Valero (NYSE:VLO) has been hit hard by narrowing differentials thanks to the Iran sanctions. Leggate says weakness in Venezuela and competition in places like Maya has also hurt VLO stock. Despite the headwinds, Valero is on track for 6% free cash flow yield in 2019, one of the highest among U.S. refiners.
A major part of the bull case for Valero is management’s commitment to capital discipline. It is now also a pure play on refining. It bought out its master limited partnership Valero Energy Partners earlier this year for nearly $1 billion.
In addition, VLO stock could be one of the big winners from changes to International Maritime Organization rules regarding fueling. These new rules should create more demand for high-grade Valero fuel.
Leggate says Valero’s cash flow profile, its 4.3% dividend and its attractive valuation make it a solid play among oil stocks. “We believe this should underpin a competitive cash return yield of >7% in 2019/2020 — fully exploiting a potential IMO super cycle,” Leggate says.
Bank of America has a “buy” rating and $128 price target for VLO stock.
Another U.S. refiner that should benefit from shippers switching to more diesel fuel blends starting in the second half of 2019 is Phillips 66 (NYSE:PSX). Phillips 66 is much more diversified within the oil industry than Valero. Phillips 66 gets about 40% of its cash flow from refining, 23% from marketing and specialties, 30% from petrochemical joint venture Chevron Phillips Chemical, and 7% from midstream oil assets. Even though the outlook for refiners looks favorable at this point, things can change quickly in the oil business. This diversification can be reassuring to investors still hesitant to go all-in on refiners.
Over the next five years, Leggate is forecasting at least $4.6 billion in operating cash flow for PSX stock. Assuming net capital expenditures of between $1 billion and $2.3 billion, the projected PSX cash flow yield of 6.5% is impressive. Leggate said the company could even push that yield to the double-digits in a bull case scenario.
Leggate also says PSX timed the completion of its USGC Petrochemical ethane and derivatives project perfectly. Chemical margins are poised to improve starting in the second half of the year, he says.
Bank of America has a “buy” rating and $126 target for PSX stock.
Last year, Marathon Petroleum (NYSE:MPC) completed an aggressive $23.3 billion buyout of Andeavor that made Marathon the top U.S. refiner by capacity. Since that deal was completed, MPC stock has traded at a significant discount to its intrinsic value, Leggate says.
“We believe that accelerating cash returns is the first step to closing the valuation gap — and with plans announced at the Dec 2018 Analyst Day, this becomes a ‘show and prove story’ that should gain credit over time,” Leggate says.
MPC stock has a projected five-year free cash flow yield of at least 15%. That yield provides the best cash returns of any major U.S. oil refiner stock. Now that the Andeavor deal is complete, Marathon will likely shift its focus from mergers and acquisitions to maximizing synergies. An estimated $1 billion in annual synergies should help boost efficiency and beef up earnings over time.
MPC stock pays a generous 3.6% dividend in addition to the company’s buyback program. Despite the company’s impressive cash flow profile, MPC stock trades at a miniscule forward earnings multiple of just 6.6.
Bank of America has a “buy” rating and $100 price target for MPC stock.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.