Do Refiners Still Offer Value?
Integrated oil stocks and some independent exploration and production firms were laggards last year. Actually, the energy sector at large was a disappointment, but one segment of the group shined brightly, providing stellar returns to investors.
Refiners, often looked at as the pesky little brother of the traditional energy equities universe, wore the crown as the king of energy sector returns in 2012. For refiners, 2012 was a stark departure from recent years where rising oil prices eroded margins and high capital expenditures pressured cash flow.
Those factors, and some others including improved crack spreads, help refiners rally last year. However, in some cases, the moves higher for some major refining were so intense that investors are left to wonder if valuations for the group are now over-extended and if further upside is available this year. The following names may offer clues regarding answers to those questions.
HollyFrontier (NYSE: HFC) Up almost 85 percent in the past year, HollyFrontier is arguably one of the poster children for a refinery name that has perhaps run too far too fast. It is a fair question as the shares were hovering around $25-$26 in June and now reside above $44.
On the basis of price-to-earnings, HollyFrontier does not appear richly valued at current levels. The shares trade for about 7.4 times forward earnings compared to the refining industry average of around 11. The shares also trade at 14.85 times price-to-free cash flow, indicating a low P/FCF ratio and that is good news because stocks with low P/FCF ratios have historically outperformed those that are richly valued based on that metric.
Worth noting is the fact that HollyFrontier paid multiple special dividends last year, making its current yield of 1.8 percent appear more anemic than it really is. As is the case with the group at large, a favorable interest rate environment that will continue through this year and probably into 2015 helps HollyFrontier on the capital expenditures side.
Northern Tier Energy LP (NYSE: NTI) Northern Tier Energy, which debuted as a public company in late July 2012, is worth of inclusion in the refinery stocks conversation due to an alluring 23.4 percent yield that translates to an expected an annual payout of $5.92 per share.
Of course, questions swirl when investors see that type of payout and yield. Rightfully so, investors are apt to ponder just how sustainable that type of dividend is, particularly when it comes by way of a newly public company. One answer to the Northern Tier dividend question comes by way of the company's corporate structure. The company is structured as a variable pay master limited partnership.
Many MLP investors are accustomed to the dividend steadiness of larger, more familiar MLPs such as Enterprise Products (NYSE: EPD) and Kinder Morgan (NYSE: KMP). However, comparing Northern Tier to those firms is an apples-to-oranges comparison. While Northern Tier has pledged to distribute all available cash in the form of dividends, the variable pay structure means when times are good for refiners, investors will likely be treated to impressive dividends from this MLP. Conversely, when refiners struggle, Northern Tier's payout will be vulnerable to some downside.
Investors should note Northern Tier is a play on the spreads between West Texas Intermediate crude and oil produced at northern locations such as the Bakken Shale. Bakken crude currently trades at $30 to $35 discount to WTI, giving some support to Northern Tier's margins.
The units trade at just 9.22 times forward earnings and 14.44 times price/free cash flow. Be advised the units have fallen about two percent in the past week and a further retrenchment could create a buying opportunity at more favorable levels.
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