My colleague Nathan Slaughter knows just about everything there
is to know about the energy industry.
He's been warning investors that just because the price of oil is
touching $100 a barrel doesn't mean you should necessarily buy
There's good reason for that. As he puts it: "It's the relationship
between oil and gasoline -- called the 'crack spread' -- that
determines profitability of an integrated oil company. So don't
assume that $3-a-gallon gasoline automatically means a cash
windfall for major oil companies." [
to find out what Nathan likes instead.]
But I've found a company that depends on the "crack spread" for
Formed in 1980, this Texas-based
company is the largest independent oil refiner in the United
States. It operates 14 refineries across North America and the
The company is one of the largest U.S. gas retailers, operating
nearly 6,000 stations across North America, under brands such as
Ultramar, Beacon and Diamond Shamrock.
It is also a top ethanol producer, operating 10 ethanol plants
around the U.S. Corn Belt.
The name of this super-sized Texas giant?
It's oil refiner
-- whose stock is trending near a two-year high -- thanks to an
increasing "crack spread."
What's the crack spread? To elaborate on how Nathan described it,
it's basically the difference between the amount a refiner pays for
crude oil and the cost to refine this oil. The greater the price
differential, or spread, the more the refiner makes. The term comes
from "cracking" large chains of hydrocarbons into smaller, finished
molecules used for products like gas and diesel.
Crack spreads have increased nearly four-fold since September 2010.
And in February of this year, they touched $25.43 U.S./barrel --
their level highest since 2007.
Pushing up the crack spread is the hefty supply of thebenchmark
crude oil West Texas Intermediate (
). There is excess supply of this U.S. feedstock because there is
not enough pipeline capacity to move the crude to the big Gulf of
Excess supply has meant Valero has had to pay less for the crude --
a perfect formula for the refiner's profits.
As a result, Valero's stock has been soaring.
Between 2009 and most of 2010, Valero was trapped between long-term
historical support (labelled on the chart below) near $14.85; and
old resistance, which has become new, major support (marked on
chart), near $22.81.
Treading near $14.85 support in August 2010, the stock bounced
off this level to form an intermediate-term uptrend line (marked on
chart). In late December 2009, the stock broke old resistance, now
major support, at $22.81, bullishly completing an
Now on an accelerated uptrend, Valero has been almost unstoppable.
On Feb. 16,shares jumped to their highest level since 2008 after
RBCCapital markets upgraded the stock.
Encountering resistance around $30.42, the stock pulled back
slightly this week, along with overall market weakness. However,
the stock remains on an accelerated uptrend and appears to be
forming a second ascending triangle pattern with resistance just
If Valero can break minor $30.42 resistance, the
for a triangle -- calculated by adding the height of the triangle
to breakout levels -- projects a price target of $41.77 ($30.42 -
$19.07 = $11.35; $11.35 + $30.42 = $41.77), a price not seen since
Fundamentally, the stock shows strong growth potential.
In the fourth-quarter of 2010, revenue increased 24% to $22.2
billion, from $17.9 billion in the year-ago quarter. Increased
crack spreads, combined with growing retail and ethanol sales drove
up revenue. From the year-ago quarter, retail sales increased $61
million, while ethanol sales jumped by $70 million.
For the full 2011 year, analysts project revenue will increase 9.9%
to $90.4 billion, from $82.2 billion. By 2012, revenue is projected
to rise another 8.7% to $98.3 billion.
Although fourth-quarterearnings were negatively affected by the
sale of the company's interest in the Cameron Highway Oil Pipeline,
Valero still managed to slim its
loss to $0.77 a share from a $2.51 per-share loss in the fourth
quarter of 2009. Excluding the sale, earnings would have been $0.32
For the full 2011 year, earnings are expected to rise 61% to $2.61
from $1.61 a year ago. By 2012, they are projected to edge up a
further 17% to $3.04.
Valero also has an attractive price-to-sales (
) ratio near 0.2 and offers a forward annual
of about 0.70%.
Action to Take -->
With strong technical signs and growing fundamentals, driven by a
wide crack spread, I believe Valero offers a good trading
opportunity and is a strong buy if it can penetrate $30.42
resistance. If you were to use my $41.77 target as calculated by
the measuring principle and the $30.42 resistance as an entry
point, you could see a 37%profit from this trade.
-- Dr. Melvin Pasternak
P.S. -- Nathan Slaughter has been doing some intense research
into natural resource plays. The supply/demand imbalance for nearly
every basic good around the world is leading to soaring prices for
gold... wheat... copper... even uranium. So on March 8 at 1:00 p.m.
EST (with opportunities for later viewing), Nathan will conduct a
special free web presentation to discuss his findings. In it, he'll
discuss three commodity markets that have reached a critical
supply/demand imbalance that could create big profits for
investors. For more information and to sign up for the free
presentation, follow this link.
Disclosure: Neither Melvin Pasternak nor StreetAuthority, LLC
hold positions in any securities mentioned in this article.
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