Are Independent Refiners Still Buys?
Shares have rallied, but valuations are still compelling as the near term remains uncertain.
2020 has taken a turn for the worse for the oil refiners. Originally well positioned to enjoy a tailwind from the implementation of IMO 2020 regulations (wider heavy crude differentials, stronger distillate margins), refiners are now slashing capacity to adapt to crashing product margins and a collapse in demand. Demand for the remainder of the year remains uncertain, with the market largely anticipating a strong summer gasoline season as U.S. travelers look to get out of the house but avoid air travel. As a result, the jet fuel market will remain weak and spill over to the distillate market as refiners blend excess jet fuel into distillate, creating excess supply.
Despite the near-term uncertainty, we think investors should get interested in refining shares for two reasons. First, while destroying near-term demand, the coronavirus should not affect long-term demand, leaving our midcycle product margin and crude differential forecast unchanged. Second, valuations are attractive and continue to discount a return to normalized conditions. While volatility in the shares probably isn’t finished, refiners are worth a look, given their valuations and low risk of near-term financial distress. On the basis of discount to our fair value estimate as well as asset-based metrics, Marathon Petroleum (MPC) stands out, followed by HollyFrontier (HFC).
Allen Good does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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