Are These Dividends at Risk?

With the rollout of a COVID-19 vaccine underway, we think there is light at the end of the tunnel for independent refiners. Although we expect that an economic recovery is likely to begin in 2021, an improvement in refining market indicators, such as inventory and utilization levels, is likely to lag. That could keep a lid on margins in the near term.

Ultimately, however, we see petroleum product demand recovering toward pre-pandemic levels, normalizing inventory and utilization levels and lifting refining margins toward midcycle levels.

The equity markets continue to price shares of independent refiners as if margins will not recover, which is keeping dividend yields near historical highs. We see little risk of dividend cuts, thanks to large cash balances and improving cash flows. As a result, refiners continue to present an opportunity as a play on economic recovery.

Given that all refiners appear relatively cheap, we'd lean toward quality. Of the refiners we cover, we prefer Valero VLO, given its superior assets and dividend safety. A rising tide of improved product demand, lower inventory levels, and higher margins will lift all boats, but as a pure-play refiner with the highest-quality assets, Valero stands to benefit while offering protection in the event the difficult environment persists for longer than expected.

Strategist Allen Good provided the research behind this segment.