Bank Of America Says A Strategic Pause Is Necessary For The US Refiners - Here's Why

BofA Securities analyst Doug Leggate said that the mid-cycle earnings power of the U.S. refining sector had been reset by a combination of capacity offshoring and a sustainable cost advantage of U.S. natural gas versus international peers. 

The analyst sees risks that margins are peaking on transitory issues, leaving an unfavorable balance of risk at the same time as seasonal trends pressure margins in coming months.

While the analyst remains confident in the level of higher average earnings in the Regional Golden Age for U.S. refiners, the risk/reward is no longer compelling. 

The analyst acknowledges that some of the factors behind recent margin strength are transitory, led by a spate of refinery disruptions, including the challenges of operating in extreme heat as a critical factor behind end of summer margin strength.

The analyst does not view valuations for the U.S. refiners as excessive and recognizes the sector's potential to overshoot.

But even assuming another year of elevated margins, the analyst sees limited impact on absolute valuations defined by DCF analysis that are dominated by the long-term mid-cycle outlook. 

For the U.S. refiners, the analyst sees risk / reward as more balanced and believes a strategic pause is appropriate to reassess next steps in what is a rapidly evolving landscape for refining.

Within the sector, the analyst sees Phillips 66 PSX, Marathon Petroleum Corp MPC, and Valero Energy Corp VLO as defensive plays with PBF Energy Inc PBF most leveraged to ongoing changes underway on the U.S. West Coast markets.

Over the past eighteen months, the analyst sees the volatile environment with seasonal margin patterns more pronounced, vindicating the view that the U.S. refining sector was entering a new regional golden age, one characterized by higher mid-cycle earnings and free cash flow for what was viewed as essentially an annuity business.

While the terminal magnitude of this new 'mid cycle' is still playing out, the initial view based on the offshoring of U.S. refining capacity and enduring cost advantage from lower-cost U.S. natural gas has been discounted by strong sector performance.

So accordingly, the analyst lowered all Buy-rated refiners to Neutral, with average upside broadly aligned across the sector.

The companies whose ratings are lowered from Buy to Neutral include PSX, MPC, VLO, PBF, and HF Sinclair Corp DINO. The analyst maintained a Neutral rating on Delek US Holdings Inc DK.

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