What are we looking for?
Relative value and strength in the oil and gas refining sector.
The screen
Within the beaten-up energy sector, midstream and downstream firms focused on transport, processing and storage of oil and gas have been able to weather the storm much better than their exploration and production counterparts. For the current year, the median three-month earnings estimate revision for the S&P 500 energy sector is minus 42 per cent compared with plus 25 per cent for the S&P 500 oil & gas refining and marketing sector.
To help identify refiners investable at reasonable valuations, my colleague Lawrence Ullman and I screened the Bloomberg database for U.S. refiners with market capitalization greater than $100-million (U.S.) and expected dividend payout ratios less than 100 per cent of earnings.
The 10 companies with the lowest EV/EBITDA multiple (enterprise value divided by earnings before interest, taxes, depreciation and amortization) are listed along with the following metrics for comparison:
– expected dividend yield;
– EV/refining throughput (enterprise value in thousands divided by the average amount of barrels of oil processed a day);
– operating margin (operating income as a percentage of total revenue);
– return on assets;
– three-month EPS estimate revision.
What we found
Valero Energy Corp. shows up relatively strong across a number of categories. Valero has been able to generate higher margins than its competitors due to its complex system of refineries, increasing flows to its Gulf Coast operations from ongoing pipeline projects and its superior capabilities of processing relatively cheaper heavy crude oil.
With an EV/refining throughput of 11.9 times and an EV/EBITDA of 4.3 times, Valero appears relatively cheap compared with peers such as Marathon Petroleum Corp., Phillips 66 and Tesoro Petroleum Corp.
Valero's rising profitability – operating margin of 4.5 per cent and return on assets of 6.8 per cent – are now among the highest in its industry and its ongoing expansion plans should help this trend to continue.
To test a concentrated strategy, we used Bloomberg to perform a back-test starting March 31, 2003, reselecting and equally weighting the five refining stocks with the lowest EV/EBITDA each quarter.
Over the 12-year period, this strategy would have generated an annualized total return of 28.3 per cent.
Over the same period, the S&P 500 total return index and the S&P 500 energy total return index returned 9.9 per cent and 12.1 per cent, respectively.
The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Ltd. or its affiliates. Investors should contact a professional or do their own research before investing in any of the stocks shown here.
Craig McGee, CFA, and Lawrence Ullman, MBA, are portfolio managers with The Ullman Group at Richardson GMP in Toronto.