The U.S. refiners have a large competitive moat from cheap crude, cheap natural gas, the ability to process cheap heavy crude and their economies of scale.
As we flagged in "The Great Light Louisiana Sweet Debate," we felt there was a risk West Texas Intermediate (WTI)-Brent spreads could compress as early as April. This indeed occurred and we cut our 2013 earnings-per-share estimated (second quarter by 19%, third quarter by 22%) to reflect this early transition from "supernormal" to "normal" earnings.
We stress our mid-cycle earnings power is unaffected and mid-cycle target valuations are 40%-50% above current share prices. Global macro indicators look too weak for the group to rally hard -- but we'd like to draw a line in the sand after an about 15% correction from recent highs.
Several themes stand out.
Marathon Petroleum (ticker: MPC), Valero Energy (VLO) and Tesoro (TSO) could still grow earnings versus a "Supernormal 2012" despite a narrower WTI-Brent spread. Self-help and, for Marathon/Valero, a reduction in Gulf Coast crude input costs suggest the best may still be ahead.
The market is still not appreciating logistics value. While it will take time to monetize logistics in the master limited partnership (MLP) market place, there is substantial logistics value in the refining peers. Indeed, we see logistics value as a key driver of absolute upside and relative stock selection.
All but three refiners are net-cash today and the average free-cash yield is about 11% on mid-cycle earnings. Managements have substantial firepower to defend against share-price weakness.
We find most value in Marathon (logistics, Galveston Bay, Mid-Continent earnings power) and in Tesoro (Carson City, Mid-Continent earnings power, operational turnarounds).
In a separate report out today, we reinstate Valero at Neutral. We believe Valero can grow earnings, but that Marathon and Tesoro offer more value.
We downgrade Alon USA Energy (ALJ) to Underperform from Neut
. Although Alon shares have absolute upside, there is less upside than peers. In line with Credit Suisse balanced recommendations, we lower to Underperform.
We upgrade Western Refining (WNR) to Outperform from Neutral. Western Refining has had a strong turnaround performance over the past two years. Upcoming catalysts that could drive the share price higher include: 1) expanding the El Paso refinery; 2) launching a Logistics MLP; and 3) raising shareholder distributions.
-- Edward Westlake
-- Rakesh Advani
-- Scott Willis