Profit From Market Overreactions And The Energy Boom -- At The Same Time

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If you hadn't noticed, the major refining stocks have been taking it on the chin lately. But is this another buying opportunity from Mr. Market -- or a sign of things to come?

Well, it might be a bit of both.

The key issue is that a slight change in the export law could put serious pressure on refiners. (My colleague Chuck Marvin touched on this in a recent column .) However, the market is treating refiner stocks as though this law has already been changed -- but it hasn't.

The reward of owning the top refiners might well outweigh the risk. Many of these refiners still offer solid dividend yields and are compelling from a valuation standpoint.

For instance, consider a few of the nation's top refiners: Valero Energy (NYSE: VLO ) , Marathon Petroleum (NYSE: MPC ) , and Phillips 66 (NYSE: PSX ) . Share prices of all three are in the red over the last month, while the S&P 500 Index is in the black:

VLO Chart

VLO data by YCharts

Shares of all the refiners crumbled the other week when two companies, Pioneer Natural Resources (NYSE: PXD ) and Enterprise Products Partners (NYSE: EPD ) , were given permission to export condensate. But the current ban on crude oil exports is still intact.

Compared to unrefined crude oil, condensate is a refined product. Hydrocarbon liquids produced in the U.S. must be processed in the U.S. That's still the case -- so there's still plenty of oil for the major refiners to refine. Let's take a closer look at three of the biggest names.

The fourth-largest U.S. refiner by capacity, Phillips 66 has 15 refineries across the U.S. and stakes in refineries in Europe and Asia. The beauty of Phillips 66 is it has invested heavily in logistics and transportation, which allows its refineries to be integrated with transportation and commercial operations. As a result, Phillips 66 has some of the best margins and returns in the industry.

Back in May, I highlighted PSX as one of Warren Buffett's favorite stocks. Shares were steadily moving higher until tumbling the past couple of weeks. Its 2.3% dividend yield does offer some downside protection.

Valero is the world's largest independent petroleum refiner with 16 refineries. Its total refining capacity is upward of 1.9 million barrels a day. The majority of its oil travels through the Mid-Continent to the Gulf Coast. The largest refiner on the Gulf Coast, Valero should continue benefiting from the increased supply of oil from the booming shale plays. The increased supply and lower input costs should continue to be a key advantage for Valero.

Marathon Petroleum is the third-largest U.S. refiner, with seven refineries and daily capacity of 1.7 million barrels. Marathon has been focusing on the East Coast, which includes connecting its Texas refineries to markets all over the nation.

Valero is the cheapest refiner of the three on a price-to-earnings (P/E) basis. VLO trades at a trailing P/E ratio of 9.2, which compares favorably with PSX and MPC, which trade at P/E's of 12.5 and 15.1. What's more, Valero is a great " growth at a reasonable price " (GARP) opportunity, with a P/E to growth ( PEG ) ratio of a mere 0.65. Phillips 66 has a PEG ratio of 1.5, while Marathon's is 1.4.

Even though PSX trades with the highest P/E of the three, it does so for a reason. Phillips 66 has the best return on assets and net profit margin, coming in at 13.5% and 4%, respectively, with each more than double its two peers.

Phillips 66 also has the highest dividend yield of the three at 2.3%, compared with Valero at 1.7% and Marathon at 1.9%. All three have similar debt-to-equity ratios, and all three have enough cash on their balance sheet to cover over 10% of their respective market caps.

Risks to Consider: The biggest risk is that the U.S. government's approval of condensate exports is a sign of things to come. If the government decides to open up crude oil for export, that would decrease the amount of oil available for U.S. refiners to process. A narrowing of the Brent and West Texas Intermediate spread, which we've seen recently , could further squeeze refiner margins.

Action to Take --> Buy Valero as one of the cheapest stocks in the refining industry. If VLO traded closer to the industry average P/E of 15, it could trade at upwards of $67 -- 36% higher than current levels. Also, buy Phillips 66 as one of the industry's best operators, a 2.3% dividend yield and an average analyst price target of $90, which represents upside of 13%.




The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Stocks

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