Hot Stock for a Cool Market: Western Refining Has Slick Profit Potential
byJul 12th 2011 11:00AM
Summer's already blazing, but apparently, the stock market didn't get the memo. Still, there are plenty of places for burned investors to find respite. In this series we highlight companies that have the potential to warm up your portfolio's returns.
For the past couple of decades, June has generally been the Dow Jones Industrial Average's worst-performing month. During most of last month, Western Refining (WNR) followed that grim trend, falling as much as 16.5%. However, its shares have since perked up -- and I believe they have much farther to go.
Western Refining is an independent refiner, breaking down (or "cracking") oil into gasoline, diesel and jet fuel, among other products. It operates two refineries in the Southwest, one in El Paso, Texas, and the other near Gallup, N.M. A third refinery near Yorktown, Va., is offline while Western converts it to a pipeline terminal and storage facility. The company also operates a wholesale business -- selling fuels, lubricants, and various automotive chemicals -- and a retail business in the Southwest.
Refiners make their money off the "crack spread" -- the difference between the price of crude oil and finished products such as gasoline. The wider that spread per barrel, the more profitable the refining business.
For Western Refining, that spread is fairly wide right now. It averaged better than $18 per barrel in the first quarter, up from just $7.40 a year previously. Currently, it is expected to remain around $20 per barrel all the way through 2012.
Western Refining's Healthy Glow
Since the end of last year, the price difference between Brent North Sea crude oil and Western Texas Intermediate oil, which is delivered to Cushing, Okla., has grown dramatically. Historically, the price difference has been only a few dollars, but since last December, it has expanded to as much as $20 per barrel.
Why? No one's entirely sure. Disturbances in the Middle East and North Africa -- most recently, the Libyan civil war -- may have driven up the price of Brent oil. Meanwhile, the middle of the U.S. is producing more oil than it can easily store, holding WTI's price down.
Whatever the reasons, closing the gap will take a while. To help, the International Energy Agency recently began to release 60 million barrels over 30 days. Dahlman Rose & Co. analyst Sam Margolin said: "It's a small amount of oil the IEA is going to release, and it makes for a nice headline, but it doesn't change the fundamental picture. Nobody thought the $20 spread was going to last, but it's still looking pretty healthy."
Therein lies the opportunity for Western Refining. Western doesn't need Brent oil. Instead, it uses the cheaper oil produced in the middle of the continent, tying its prices to that lower WTI price. In the first quarter, this improved Western's margins, helping to swing the company from a loss last year to a profit this year.
Net Margins Are Beginning to Bubble Up
Relatively cheap crude and high finished product prices will likely help Western Refining raise operating and net income margins from their current low levels. That growth has already begun, as the graph below reveals:
Source: Capital IQ, a division of Standard & Poor's. TTM = trailing 12 months.
As long as crack spreads remain wide, I expect this trend to continue, with net margins climbing back up to more historic levels above 2% or 3%.
In 2010 and so far in 2011, Western Refining's two active refineries are operating at higher margins than all but one of the refineries operated by Tesoro (TSO), Frontier Oil (FTO), and Holly (HOC), and all the refineries operated by Valero (VLO).
Two Potential Flashpoints
Despite Western Refining's share price rise this year, the market is still pricing in very low expectations for free cash flow growth. On one hand, I believe Wall Street is reacting to uncertainty about the stability of the Middle East and its oil supplies. On the other, I think investors are also nervous about the U.S. economy and its effect on gasoline demand.
But as I noted before, Western Refining doesn't depend on Middle Eastern or African oil. Furthermore, the U.S. Energy Information Administration, in its June 7 report, expects consumption of distillate fuels (i.e., gasoline) to increase both this year and next, pegging automotive gasoline as next year's fastest-growing category.
Motley Fool analyst Jim Mueller doesn't own shares of any company mentioned. The Motley Fool owns shares of Western Refining.