Oil prices are up, and that could be bad news for highly-valued refining stocks like HFC

October 4, 2018

Oil prices are up, and that could be bad news for highly-valued refining stocks like HFC

If you’ve been paying attention to energy prices over the last six weeks or so, you’ve observed a pretty impressive rally in oil. Since August 15th, when it hit a pivot low at around $65 per barrel, West Texas Intermediate crude has jumped almost 14% to its current level at around $75.50. The surge in Brent crude has been even bigger, going from around $71 per barrel to a little above $86, or almost 22% over the same period. Those moves mark what looks like a breakout for both commodities above ranges that had been holding since early spring of this year. Higher oil prices are indicative of a lot of different global economic factors, like pending U.S.-imposed sanctions on Iran to restrict their ability to sell their oil on the global market, and reports that China might be forced to cut its imports of Iranian as well seem to be adding to pressure on global supply. An increasing number of analysts seem to think oil could push close its historic, pre-2014 highs around $100 per barrel. That’s a good thing, right?

If the surge in oil prices continues, or even if the price merely consolidates for the time being around its current levels, I think it’s pretty reasonable to thing that oil drillers and producers like Marathon Oil Corporation (MRO) and Pioneer Natural Resources (PXD), or the really big boys like Exxon Mobile Corp (XOM) and Chevron Corp (CVX) will see their profits keep increasing – which should be a good think for the foreseeable future for their stock prices. On the other hand, refiners like HollyFrontier Corporation (HFC), Marathon Petroleum Corp (MPC) and Valero Energy Corp (VLO) seem to be at greater risk in the current scenario, since rapidly rising oil prices increase refining costs and make it harder for these companies to make necessary adjustments to contain and manage those costs.

HFC is a very interesting case study, because in almost every respect, their fundamental profile is very healthy, which along with the stabilization of oil prices has enabled the stock to break its pre-2014, and all-time highs and create a new peak at the beginning of June above $80 per share. Since hitting that high, however, the stock has trailed backwards, declining a little over 13% over that period, and forming a technical price pattern that could indicates market momentum and enthusiasm continues to wane. The stock is now is significantly overvalued territory, which suggests that risk in the stock right now is much higher than any potential reward. If oil prices continue to climb, expect margins for HFC to continue to contract. Another factor that could continue to put pressure on HFC’s cost structure is the fact that a significant portion of their business comes from the Midcontinent and Southwest areas of the U.S., where infrastructure limitations have constrained the transportability of shale oil to the market.



Fundamental and Value Profile

HollyFrontier Corporation is an independent petroleum refiner. The Company produces various light products, such as gasoline, diesel fuel, jet fuel, specialty lubricant products, and specialty and modified asphalt. It segments include Refining and Holly Energy Partners, L.P. (HEP). The Refining segment includes the operations of the Company’s El Dorado, Kansas (the El Dorado Refinery); refinery facilities located in Tulsa, Oklahoma (collectively, the Tulsa Refineries); a refinery in Artesia, New Mexico that is operated in conjunction with crude oil distillation and vacuum distillation and other facilities situated 65 miles away in Lovington, New Mexico (collectively, the Navajo Refinery); refinery located in Cheyenne, Wyoming (the Cheyenne Refinery); a refinery in Woods Cross, Utah (the Woods Cross Refinery), and HollyFrontier Asphalt Company (HFC Asphalt). The HEP segment involves all of the operations of HEP. HEP is a limited partnership, which owns and operates logistic assets. HFC’s current market cap is $12.6 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings increased almost 120%, while sales increased by a little over 29%. In the last quarter, however, earnings grew more than 88% while sales grew 8.3%. HFC’s margin profile currently shows consistency, as Net Income over the last twelve months was 7.6% of Revenues. This measurement was nearly the same in the last quarter at 7.7%.
  • Free Cash Flow: HFC’s free cash flow for the trailing twelve month period was a little over $922 million, which is healthy and translates to a Free Cash Flow yield of 7.3%.
  • Debt to Equity: HFC has a debt/equity ratio of .37, a low number that indicates the company operates with a conservative philosophy about leverage. Their balance sheet indicates operating profits are more than adequate to service their debt, with healthy flexibility from cash and liquid assets as well.
  • Dividend: HFC pays an annual dividend of $1.32 per share, which translates to a yield of 1.86% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for HFC is $36.35 per share and translates to a Price/Book ratio of 1.94 at the stock’s current price. Their historical Price/Book average is only 1.44, which suggests that the stock is trading at a premium right now of more than 26%. Their Price/Cash Flow ratio points to the reality HFC is overvalued even more dramatically, since it is currently trading 39% above its historical average. These two numbers together point to a “far value” range that could fall anywhere between $52 on the high side or $43 on the low side.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: The red diagonal line traces the stock’s upward  trend over the past year and which reached its high in early June above $80. It also informs the Fibonacci retracement lines shown on the right-hand side of the chart. I’ve also drawn a yellow diagonal, dashed line to trace the stock’s declining pattern of highs from that point, while the green dashed line demonstrates the stock’s consistent support since late June around $66 per share. The pattern of declining highs, with a stable pattern of lows marks what technicians like to call a wedge pattern. Wedges can be bullish or bearish, depending on which side of the wedge the stock eventually breaks out from. Considering the strength of the stock’s upward trend, its currently overvalued state, and the increase of oil prices over the last month or so, a break below the wedge seems more likely, with plenty of room to drop down to the mid-$40 to $50 range my value analysis identified.
  • Near-term Keys: To provide any kind of good bullish trade over any kind of time period, the stock will need to break above its wedge pattern; that won’t happen until the stock stock hits at least $72.50, with a push above $75 acting as a much better signal to start thinking about buying the stock outright or starting to work with call options. If you prefer to work with the short side opportunity with HFC, wait to see if the stock drops below its current support; a drop to $64 could be an excellent opportunity to short the stock or start buying put options.