Explaining the Weak Pre-Announcements By Refiners

Credit Suisse refiners analyst Edward Westlake published a note this morning trying to explain the underlying reason that two key refining companies, Valero VLO and then Marathon Petroleum Corp. MPC, have pre-reported weak second quarter earnings.

"VLO and MPC have both pre-announced below consensus earnings for 2Q13," he wrote. "We believe one common theme explaining the shortfall vs 2Q is narrower light-heavy diffs in the Gulf. This negatively affects Gulf Coast capture rates (something we and the street should have modeled). Light-heavy diffs will normalize over time."

However, he remains optimistic on the industry group and maintains his outperform rating and $110 price target on Marathon. When the dust settles, both VLO and MPC are generating decent EBITDA in 2Q and are FCF positive, and look undervalued (particularly given the logistics value at MPC). Investors and analysts alike will need some explanation from management teams on the calls (both on earnings, and WTI-Brent trajectory, our own views aside)."

Related: Credit Suisse Reiterates Outperform On Apple Ahead of Earnings, Sees Product Rich Second Half, PT $525.00.

Specifically for Marathon, the large cash position and recently announced buyback program should act as defense for the stock and put a floor under the price. "There is substantial cash at MPC to defend weakness with the $2.2 billion buyback authorization. Following the pre-announcement, we reduce 2Q13 EPS to $1.93/sh from $2.61/sh and 3Q13 from $2.52/sh to $2.22/sh."

Marathon Specifics

Positively, Westlake noted that Chicago product crack spreads rallied strongly in the second quarter, although MPC failed to capture all of this increase, weighing on earnings. Also Gulf Coast crack spreads improved in the quarter but again, Marathon failed to capture all of this improvement.

Negatively, he notes that the discount of WTI Crude to Brent Crude fell in the second quarter, which was a source of incremental profit to the company and all refiners previously. Also, he says that because it appears as though Marathon only captured 30 percent of the product price spike in Chicago, it explains the lowered guidance and weaker earnings. He notes that Phillips 66 PSX and PBF Energy PBF both could suffer from similar dynamics in the quarter.