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Halvorsen v. Robbins: Gurus’ Refining Picks

November 19, 2013 | About:
Industry leading integrated oil and gas companies have seen a performance slowdown as volumes in downstream operations declined. The impact, in some cases, was so important that improvements in the upstream segment were offset. However, demand is expected to rise through 2017, offering a good opportunity to analyze oil and gas refining companies. In this case, I will look at Valero Energy (VLO) and Phillips 66 (PSX).

Few Opportunities

Valero Energy’s activities are carried out in the U.S., Canada and Caribbean, where it operates 16 refineries and with a total capacity of 2.8 million barrels per day. Additionally, the firm is the largest independent refiner in the U.S., produces 1.1 billion gallons of ethanol a year and distributes refined products through over 1,000 retail fuel outlets. Through this year the firm has been experiencing lower refining margins in each of the company's regions and higher refining operating expenses.

In the short term, Valero Energy’s earnings and revenue continue to suffer, but analysts augur a prosperous future as new opportunities arise. The optimism is based mainly in the dominant positioning and narrow economic moat achieved by the firm. Furthermore, the Parkway Pipeline project with Kinder Morgan Energy Partners LP and recently completed Diamond Green Diesel joint venture biofuels plant increases processing capacity amid rising demand for oil and gas products. Additionally, the projects are anticipated to have a notable impact on earnings, expected to be seen during this year’s fourth quarter.

Looking forward, Valero Energy has reduced capital spending by 20% during 2013 when compared to 2012. More, the decline has been closely associated with the financing of two major hydrocracker projects shortly. A great risk arises from disturbances due to accidents, mechanical failure and labor issues that would hamper production and result in increased repair and maintenance expenses. Also, in the U.S. generally face uncertainty regarding future regulations pertaining to greenhouse gas emissions and the potential for higher requirement of biofuels.

The balance sheet for Valero Energy is moderate-to-weak due to thin operating margins. Currently trading at 9.7 times its trailing earnings, the stock is packing a 20% discount to the industry average. Andreas Halvorsen is the guru holding the largest stake in the firm, but his position has been reduced during the last quarter. I share his pessimism since growth opportunities are limited.

Under Construction

Phillips 66 is a downstream company also involved in power generation, lubricants and other specialty products businesses, with operations mainly in the U.S., Europe and Asia. The company operates 15 refineries with a total throughput capacity of 2,485 m/d, in addition to a joint venture of 61 natural gas processing facilities, 12 NGL fractionation plants and a natural gas pipeline system with 62,000 miles of pipeline. The company is also a partner in a chemical joint venture that operates facilities in the U.S. and the Middle East, which primarily produces olefins and polyolefins.

Ahead, Phillips 66 has to return its refining operations to a profitable path. During the current year, refining operations have lagged behind the other three segments the firm operates. However, prospects for the refining industry are limited and competition is high. Hence, the company may have better results if the portfolio’s weight tilts towards the midstream and chemical segments. These two segments have driven growth to the extent of offsetting lagging midstream operations.

For the long-road, Phillips 66’s refining competitive position and asset base is considerably below that of Valero Energy’s. Its competitiveness, however, is not under questioning thanks to a greater availability of discount crude for the East and West Coast refineries. This has been possible due to important investments in transport logistics in naval and rail assets. Although better results are expected once the business restructuring away from refining is on full speed, the effect on performance is not expected to be meaningful.

Financially, the Phillips 66 valuation is moderate due to thin margins and declining revenues. The stock currently trades at 11.6 times its trailing earnings, barely below the industry average. Larry Robbins, the guru with the largest stake in the firm, has increased his position throughout 2013. I do not share his optimism because the restructuring announced will not have a great impact in overall performance.

Troubled Present, Questioned Future

The analysis highlights Valero Energy’s better standing in comparison with Phillips 66, and the second’s activities diversification. I feel pessimistic about both because there are no clear growth catalysts in the near future, and a rising demand is not enough to justify a long-term investment.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.

About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website


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