It looks like it will be an ugly start to the week, as the market focuses back onto the intractable problems of Spain and Europe. If we do see a substantial selloff, I plan to add to my positions in the refinery sector. I first outlined my reasons for believing the refiners were deeply undervalued back in a late April column. Since then, all of those selections have easily outperformed the overall market.
I still believe there is plenty of value left in the refinery space. Refining equities still (A) sport cheap valuations, (B) are benefiting by solid crack spreads, (C) have strong free cash flow due to reduced capital spending needs, (D) have operating margins that are benefiting from low natural gas prices, and (E) have plenty of room to raise dividend payouts. Here are two refinery stocks I like at their current levels.
Valero Energy (VLO - Get Report) is as an independent petroleum refining and marketing company. The company owns 16 petroleum refineries that have a combined throughput capacity of approximately 3 million barrels per day.
Four reasons VLO is a solid pick at $25 a share:
- The stock is selling near the bottom of its five-year valuation range based on P/B, P/E, P/CF and P/S.
- VLO yields 2.3% and Evan Calio at Morgan Stanley believes it could double its dividend by the end of FY2013, due to its relatively low payout ratio and robust cash flow.
- The stock sports a cheap forward PE below 6, which is a significant discount to its five-year average (10.8). It also sells for less than 4x operating cash flow.
- VLO is starting to get some notice from the analyst community. Dahlman Rose initiated the stock as a Buy in late April, UBS upgraded the shares to a Buy from a Neutral in mid-June and S&P has its highest rating and Credit Suisse has an Outperform rating and a $37 price target on Valero.
- The stock is cheap, trading at just over 7x forward earnings and 89% of book value.
- The company just paid its first dividend since becoming an independent company in July. The stock yields 2.3% and I would look for management to consistently increase the dividend payout in the years ahead.
- Consensus earnings estimates have increased approximately 4% for both fiscal-year 2012 and fiscal-year 2013 over the past two months.
- Analysts are starting to follow Phillips after the spinoff. Oppenheimer initiated coverage on the shares with an Outperform rating and Argus initiated PSX as a Buy in July. S&P and Credit Suisse also have positive ratings on the stock.
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