Inside Wall Street: Little-known HollyFrontier rises

The independent petroleum refiner, created after a July 2011 merger, is climbing to new highs.

By Gene Marcial Oct 17, 2012 6:34PM

Oil derricks -- Comstock/CorbisHardly a household name, HollyFrontier (HFC) is nonetheless starting to get some top billing on Wall Street for its strong generation of cash flow and returning cash to shareholders through rising regular dividends, special payouts and steady share buybacks.


The young company, a product of a merger in July 2011 between Holly Corp. and Frontier Oil Corp., is now one of the largest independent refiners in the U.S.


HollyFrontier has a market value of $8 billion and 2011 sales of $19.2 billion, and has seen shares surge to a new high of $42.33 on Sept. 14. In its brief trading history, the stock has been an impressive winner, rising from a low of $21 on Nov. 25, 2011, to Wednesday's close of $38.40.


Although profit taking has dropped shares, that opens a still-attractive entry point for those not yet in the stock.


“We bought shares of HollyFrontier at $40.10 a share on Sept. 26, 2012, and although it has reached a multi-year high in price recently, we believe the stock is still a very good value,” says Joseph F. Hunt, principal at Northwest Criterion Asset Management.


As is true for all the energy companies, HFC’s fortunes are greatly influenced by the macro-economic situation, but HollyFrontier’s fortunes, says Hunt, "inhabits a niche which we think will continue to benefit it for some time to come."


Because of the strategic geographic location of HFC’s five refineries, they have access to large supplies of WTI oil, which for some time now has traded at quite a discount to Brent crude. That means the company is able to gain large profit margins from its refining operations.


"We expect this situation to continue for some time," predicts Hunt. Moreover, HFC has upgraded its refineries to more efficiently process less expensive heavy crude oil and thereby derive a cost advantage over competitors, he notes.


As big a winner as HFC has been, its stock is still inexpensive, says Hunt, trading at a price-to-earnings ratio of 5.3 compared to bigger refiners that, on average, trade at 20 times earnings. HFC’s current P/E is near the low end of its five-year trading range.


With its debt/equity rate of less than 25% and strong cash flow, HFC has been able to regularly pay dividends -- and since mid-2011 provide special dividends -- and buy back its own shares. HFC’s gross margins of 14% and operating margin of 12% are both above the industry average.


With its projected steady earnings over the next year and a move in HFC’s multiple closer to eight, but still below the industry average, "we can see the stock price reaching the mid-$50s," says Hunt.


In the meantime, the company has the cash cushion and cash flow to continue its winning ways.


"HFC has the financial flexibility to continue to fund its regular and special dividends and share buybacks this year and next," says veteran oil industry analyst Fadel Gheit of investment firm Oppenheimer, who rates the stock as "outperform." With more cash than debt, HFC has a projected cash flow of $1.8 billion for this year, and $1.4 billion next year, and capital expenditures of $335 million in 2013 and $365 million in 2014. So HFC, notes Fadel, is in a great financial shape.


Gheit points out that HFC has led the industry in unit profit this year and in the past five years because its refineries are located close to the major crude-oil hubs in the midwest, southwest and Rocky Mountain regions. They produce cheap and "high complexity" petroleum, which allows the refineries, says Gheit, to process a wide variety of discounted crude into high-value gasoline and diesel fuel.    


This combination of "refinery complexity, crude flexibility, and growth markets gives HFC strong competitive advantages," says Gheit. So the analyst has raised his earnings estimate for 2012 to $7.39 a share from $7.07, up from 2011’s $6.44.


In sum, investors still seeking an oil-patch investment should find this pure-play in oil refining with an improving dividend yield an attractive opportunity at its current valuation.

Gene Marcial wrote the column "Inside Wall Street" for Business Week for 28 years and now writes for MSN Money’s Top Stocks. He also wrote the book "Seven Commandments of Stock Investing," published by FT Press.

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