2 picks for investors with refined tastes
HollyFrontier has resilient margins, lots of cash and pays good dividends, while Tesoro dominates the West Coast thanks to a generous deal with BP.
By Igor Greenwald, Personal Finance
Tesoro has been the standout year-to-date with a gain of 29%. Meanwhile, HollyFrontier is the clear refining laggard, with a 41% one-year gain, and now down year-to-date. Despite its startlingly strong fundamentals, HollyFrontier has been plagued by fears that its future isn't as rosy as its past.
Investors are obsessed with the titanic efforts to move the millions of barrels of crude flowing out of tight oil formations in the North American interior to the largest and most complex refineries on the Gulf Coast. The effort is already driving up costs for HollyFrontier, whose mid-continent refineries used to have fewer viable competitors for the cheapest crude feedstock.
HollyFrontier's crude cost of products averaged $92.68 per barrel in the first quarter of 2013, down from $102.08 a barrel a year earlier. Gross margin was up 34% to $23.32 per produced barrel, helping the company to overcome the drag from heavy scheduled maintenance.
HollyFrontier's five refineries sit on top of or in close proximity to productive and promising production basins, and are likely to enjoy considerable price advantage on the purchased crude long after the Gulf Coast has been sated with similar product.
These resilient margins are likely to support continued generosity with regular and special dividends, which have yielded 7.6% of the current share price over the last 12 months. HollyFrontier is also selectively nibbling on its shares through a $500 million share-repurchase authorization, backed by the company's $2.5 billion cash hoard.
The stock has lagged amid hedge-fund selling, Wall Street price-target cuts, and the sense that HollyFrontier's best days are behind it. But the medium-term fundamentals remain superb, and this is a good time to buy.
Meanwhile, nearly two-thirds of the crude Tesoro recently consumed was of the cost-advantaged variety from the continental interior.
The case for the stock's continued outperformance rests with the recently completed acquisition of the Carson, California refinery from BP (BP) for a price so low it left the industry wondering how Tesoro landed this steal of a deal. Tesoro paid all of $1.1 billion (net of inventory) for an asset that generates roughly $500 million of EBITDA (earnings before interest, taxes, depreciation, and amortization) annually.
The Carson plant will account for 31% of Tesoro's capacity, and make it the dominant refiner on the West Coast, as well as in southern California, where it will have a third of the entire refining market and supply half the jet fuel used at the Los Angeles International Airport.
Tesoro paid BP perhaps one-tenth of what might be considered a decent multiple. Better still, the Carson plant sits just a half-mile from a smaller refinery Tesoro already owns, promising annual synergies valued at $250 million annually after some relatively modest capital improvements.
It's hard to fathom why BP sold this cheaply, other than its big hurry to get out of the US refining business and to raise funds for the huge, and growing, costs of its 2010 Gulf of Mexico oil spill. But its haste has left Tesoro sitting pretty, with added regional retail muscle, thanks to 800 southern California filling stations included in the deal.
The deal is expected to fuel a spike in free cash flow to $1.1 billion in 2014, up from $800 million this year.
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