Are Refiners Too Cheap to Ignore?
In this difficult industry, companies look undervalued but face many challenges.
A little more than a year ago, independent refiners like Valero (VLO) and Tesoro (TSO) were flying high. Early in the summer of 2007, gross refining margins reached multidecade highs, soaring above $40 per barrel refined in some regions. Many forecasted a "golden age of refining" that would last for many years. In our view, many of the refining stocks were pricing in peak refining margins into perpetuity, valuations that weren't likely to hold up forever. During the last year, refining industry fundamentals have changed dramatically, and share prices have come down considerably. Valero is down about 75% during the last 12 months, Tesoro is down almost 85%, Frontier Oil (FTO) is down more than 75%, Sunoco (SUN) is down more than 65%, and Western Refining (WNR) is down more than 80%. So is now the time to consider investing in refiners?
What Has Changed
In late 2006, my colleague Justin Perucki wrote about some refining trends he was watching. Many of these trends have finally started to play out and are contributing to the recent weakness in refining fundamentals and stock prices. First, both globally and in the United States, refining capacity has been growing for the last decade. Many of us have heard the argument: "A new refinery hasn't been built in the U.S. since the late 1970s." Unfortunately, that slogan is misleading. Although no new refineries have been built in the U.S. recently, refining capacity has been steadily creeping upward as existing refineries have been expanding output. Second, refineries in the U.S. have invested heavily in improving their complexity during the last few years. These moves have increased the refining industry's capacity to process lower-quality crudes and produce higher-margin products out of existing facilities. Thus the overall refining marketplace should become more competitive as complexity increases in aggregate.
Eric Chenoweth has a position in the following securities mentioned above: CVX, XOM. Find out about Morningstar’s editorial policies.