Last year was a bruising one for the Zacks Oil and Gas – Refining & Marketing industry, with the coronavirus-induced lockdowns slamming fuel usage. While the refining economics remain under pressure, industry players like Phillips 66 (PSX), Marathon Petroleum (MPC), Valero Energy (VLO) and HollyFrontier Corporation (HFC) are expected to benefit from a modest uptick in utilization and gasoline demand.
The Zacks Oil and Gas – Refining & Marketing industry consists of companies that are involved in selling refined petroleum products (including heating oil, gasoline, jet fuel, residual oil, etc.) and a plethora of non-energy materials (like asphalt, road salt, clay, and gypsum). Some of the companies also operate refined products’ terminals, storage facilities and transportation services. The primary activity of these firms involves buying crude/other feedstocks, and processing them into a wide variety of refined products.
3 Trends Defining the Oil and Gas – Refining & Marketing Industry’s Future
Surging RIN Costs Impact Profit Margins: U.S. refiners are feeling the pinch of higher Renewable Fuel Standard (“RFS”) costs to comply with cleaner gasoline production rules. By law, the downstream operators are required to mix renewable fuels (like corn ethanol or other biofuels) into gasoline and diesel. Recently, prices of U.S. renewable fuel credits — known as Renewable Identification Numbers, or RINs — hit multi-year highs. This translates into additional operating cost for refiners who have to buy these RIN credits to meet the RFS standard. Already reeling under an environment of depressed profit margins, the additional cost of RINs have put most refiners under pressure.
Fuel Demand Remain Suppressed: Per the U.S. Energy Department’s latest inventory release, distillate inventories are around 4% above the year-ago-level, signaling plenty of oil product availability in the market. Therefore, fuel margins remain depressed. Further, with coronavirus still keeping the majority of customers away from air travel, consumption is yet to recover meaningfully. While leisure travel demand has gradually improved from the dramatic lows, business travel demand continues to be significantly weak. As a result, the already dire jet fuel (a derivative of distillates) market is unlikely to rebound anytime soon. This will not only affect refining profitability but also result in increased price volatility.
Rising Chinese Activity Bode Well: On a slightly positive note, gasoline sales in the United States continued to tick up in recent months in a recovery from the historic lows as the economy reopened and lockdown measures imposed to curb the coronavirus pandemic were eased. While restrictions have returned in a number of countries to curb the fresh wave of the virus, they are not as drastic as the ones that followed immediately after the pandemic’s outbreak. Further, oil product demand in China — the world’s second-largest energy consumer — has been gradually increasing and is now almost back to the pre-pandemic levels. While overall usage remains well below the pre-virus levels and stockpiles have bloated, the refining and marketing operators should benefit from improved activity and will have a favorable impact on profitability.
Zacks Industry Rank Indicates Gloomy Outlook
The Zacks Oil and Gas – Refining & Marketing is a 14-stock group within the broader Zacks Oil – Energy sector. The industry currently carries a Zacks Industry Rank #172, which places it in the bottom 32% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates challenging near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of the negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic on this group’s earnings growth potential. While the industry’s earnings estimates for 2021 have decreased 64.3% in the past year, the same for 2022 have fallen 26% over the same timeframe.
Despite the dim near-term prospects of the industry, we will present a few stocks that you may want to consider for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and its current valuation first.
Industry Outperforms Sector & S&P 500
The Zacks Oil and Gas – Refining & Marketing industry has fared better than the broader Zacks Oil – Energy sector as well as the Zacks S&P 500 composite over the past year.
The industry has surged 59.6% over this period compared to the S&P 500’s rise of 56.2% and broader sector’s increase of 41.1%.
One-Year Price Performance
Industry’s Current Valuation
Since oil and gas companies are debt laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of noncash expenses.
On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA), the industry is currently trading at 147.53X, significantly higher than the S&P 500’s 18.19X. It is also well above the sector’s trailing-12-month EV/EBITDA of 6.13X.
Over the past five years, the industry has traded as high as 157.68X, as low as 4.23X, with a median of 8.54X, as the chart below shows.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
4 Oil and Gas – Refining & Marketing Stocks to Focus On
Valero Energy: Valero Energy Corporation is one of the largest independent refiners and marketers of petroleum products in the United States. It has a refining capacity of 3.2 million barrels per day across 15 refineries located throughout the United States, Canada and the United Kingdom. The company’s outlook remains healthy on the back of an improving refining picture, a leg up in its renewables business and cost cuts.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Valero Energy has an expected earnings growth rate of 158.97% for the current year. The fuel distributor carries a Zacks Rank #2 (Buy) and its shares are up 67.2% over the past six months.
Price and Consensus: VLO
Marathon Petroleum: Marathon Petroleum’s $23.3 billion acquisition of Andeavor has integrated the premier assets of both companies, bolstering the scale and leadership position of the combined entity in the United States. As it is, Marathon Petroleum’s access to lower cost crude in the Permian, Bakken, and Canada helps it to benefit from the large differentials.
Marathon Petroleum has an expected earnings growth rate of 126.16% for the current year. The downstream operator carries a Zacks Rank #3 (Hold) and its shares are up 72.5% over the past six months.
Price and Consensus: MPC
Phillips 66: Phillips 66 is the leading player in each of its operations like refining, chemicals and midstream in terms of size, efficiency and strength. The company’s top-class asset portfolio, financial strength and ability to lower cost structure should boost shareholder returns.
Phillips 66 has an expected earnings growth rate of 479.78% for the current year. The Houston-TX based firm carries a Zacks Rank #3 and its shares are up 50.7% over the past six months.
Price and Consensus: PSX
HollyFrontier: HollyFrontier is one of the largest independent oil refiners in the United States with a combined crude oil processing capacity of approximately 457,000 barrels per day. A major advantage for the company is the high complexity index – or the capability to process a wide mix of crude – and access to some of the fastest-growing domestic markets afforded by its portfolio of five refineries.
HollyFrontier has an expected earnings growth rate of 181.61% for the current year. The downstream operator carries a Zacks Rank #3 and its shares are up 71.7% over the past six months.
Price and Consensus: HFC
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