Western Refining


is branching out.

The company will soon operate four refineries -- up from one right now -- following a planned $1.22 billion buyout of

Giant Industries


. It will expand into new businesses, picking up 159 gas stations, as part of the deal as well.

Western has agreed to pay $83 in cash for each share of Giant, representing a 16% premium over Giant's most recent closing price. Western will also assume $275 million of Giant's outstanding debt.

The combined company is set to emerge as the fourth-largest independent refiner and marketer in the country.

"The acquisition is a plus for Western," says Harry Chernoff, a principal at Pathfinder Capital Advisors who owns the stock. "Refining and marketing assets are undervalued in the market, and Western is picking up quality assets at a reasonable price. ... As long as the refining sector stays strong, Western will do extremely well."

Notably, Chernoff points out, Western has predicted that the transaction will be "immediately and significantly accretive" to the company's earnings and free cash flow. Western was already posting above-average cash flow before the deal was announced, he says -- meaning shareholders should now enjoy even bigger returns.

Western's stock slipped 11 cents to $25.87 on Monday, while Giant surged $10 to $81.79 on the news.

Good Deal

Like Chernoff, Merrill Lynch analyst Christopher Moore clearly feels that Western is getting its money's worth.

"The Giant acquisition gives WNR increased exposure to one of the key fundamental strengths behind our buy recommendation: premium, southwest niche refining margins," Moore wrote on Monday. "Also, the transaction reduces the risk and volatility around WNR's single refining asset and diversifies earnings outside of the southwest market."

Currently, Western operates just one refinery from its home base of El Paso. Following the deal, however, the company will run two refineries in New Mexico -- further strengthening its presence in the high-margin southwest market -- as well as a refinery in Virginia that can help meet East Coast demand.

All told, the deal will increase Western's refining capacity by some 84% to 216,000 barrels a day. Moreover, the deal will significantly enhance the amount of sour crude the company can process going forward. The ability to process sour heavy crude -- which is cheaper than lighter oils -- can boost margins dramatically.

And Western boasts outstanding margins already.

"Results in 2Q show how the company ... has above-average organic growth opportunities and can achieve a margin on par with industry leaders," wrote Moore, whose firm counts Western as an investment banking client. Notably, "


(VLO) - Get Report

realized gross margin for 2Q was comparable."

Now, Western's margins could get even better. Following its acquisition of Giant and some upgrades at its current refinery, the company should be able to use sour crude for nearly half of its refining activities.

Early Call

Nevertheless, Banc of America -- Western's advisor on the deal -- downgraded the company's stock a couple of weeks before Monday's big announcement. The firm's analyst, Philippe Lanier, pointed out on Aug. 10 that the company's stock had already rallied 54% since early June and could settle down as a result.

Thus, he cut Western from buy to neutral even while applauding the company's recent performance.

"Despite the numerous positives in the quarter, we believe fair value is priced into the stock and, as margins moderate ahead, we see insufficient support for further upside barring a significant industry catalyst," Lanier wrote at the time. Moreover, "recent flooding in El Paso highlights the risk a single-refiner investment poses. ... Production and profitability should continue to improve over the next few years -- and, as such, we remain holders" of the stock.

Banc of America has investment banking relationships with Western and Giant alike.