(NYSE: VLO) (NYSE: PSX) These oil stocks love $40 crude

(NYSE: VLO) (NYSE: PSX) These oil stocks love $40 crude

The collapse in oil and gas prices over the past year has been well-documented, and a great source of pain for most of the traditional energy industry. Since the current crisis began, the price of oil in the United States, dictated by the West Texas Intermediate price, has fallen from above $100 per barrel at its peak, to its current level of $36 per barrel. Not surprisingly, this has been a serious blow to companies engaged across the oil spectrum, particularly hitting upstream exploration and production companies. Also affected are midstream pipeline companies, albeit to a lesser degree.

However, the one group that has not just been surviving the current downturn, but actually thriving, is oil refiners. Companies like Valero Energy (NYSE: VLO) and Phillips 66 (NYSE: PSX) are actually benefiting from oil’s steep decline to below $40 levels. Their stock prices reflect their success, and are sitting near their highs for the year. And, thanks to their shareholder-friendly management teams, Valero and Phillips 66 are sharing their increased profits with investors through major stock buyback announcements and increased dividends.

As the energy landscape adjusts to lower energy prices and regulations shift to greater emphasis on greenhouse gas emissions, there are still some bright spots.

Why Refiners are Benefiting from Cheap Oil

It may surprise investors to know that a certain corner of the energy market could actually perform better when oil prices decline, but it is indeed true. Over the past year, oil refiners have actually seen their profitability improve as the price of oil collapsed. The reason for that is because as oil falls, so do refining feedstock costs. This expands refiners’ spreads and margins, and results in a huge boost to earnings.

For example, Valero’s profit from continuing operations reached $1.4 billion, or $2.79 per share, last quarter, compared to $1.1 billion, or $2.00 per share, year over year. That represents a 39 percent earnings growth rate. Over the first nine months, its earnings per share grew 57 percent, compared to the same period last year.

For its part, Phillips 66’s adjusted earnings are up 21 percent year-to-date through the third quarter. Going forward, Phillips 66 has several projects in the works to keep profits growing. These include the Sweeny Fractionator One, with a capacity of 100,000 barrels per day, and the Freeport LPG Export Terminal, with capacity for 150,000 barrels per day. The Sweeny project announced first startup on Dec. 8. The Freeport project is 50 percent complete, and is on schedule to ramp up in the second half of 2016.

Thanks to their improving financial performance, Phillips 66 and Valero Energy have been excellent performers this year. Phillips 66 and Valero Energy shares have gained 21 percent and 45 percent, respectively, since the start of the year. Their strong underlying business fundamentals are the reason why Phillips 66 and Valero have bucked the broader trend dragging down the energy sector as a whole.

Profits, Dividends on the Rise

The increase in profitability has resulted in strong earnings growth, which is being shared with investors through compelling dividends. While many oil and gas companies are cutting dividends to keep their cash flow afloat, or suspending their dividend payouts altogether, the refiners are busily increasing dividends, and rewarding investors with large share buyback programs.

Valero raised its dividend by 45 percent at the beginning of the year, and then by another 20 percent when it announced third-quarter earnings results. In all, its new quarterly dividend is almost double the fourth-quarter dividend last year. At its recent closing price, the stock yields 2.8 percent. Similarly, Phillips 66 raised its own dividend this year, by 12 percent, and that stock yields 2.6 percent. And, the company recently approved a $2 billion addition to its share buyback program.

The refiners’ success is starting to get the attention of some high-profile investors. None other than Warren Buffett, the Oracle of Omaha who is widely regarded as the most legendary investor of all time, made a major purchase of Phillips 66 earlier this year. Buffett recently filed a 13F document with the SEC, as he is the Chairman of investment conglomerate Berkshire Hathaway (NYSE: BRK.B). Berkshire has taken a 10 percent stake in Phillips 66, equating to a nearly $5 billion investment.

Environmental Aspects

The Carbon Disclosure Project, or CDP, aims to change the way the business world reacts to the dangerous threats posed by climate change, by seeking more expansive environmental reporting, while promoting the responsible use of natural resources. The CDP brings together several different stakeholders, including investors, customers, and governments, to incentivize companies to disclose their environmental data. CDP then issues companies a score and grade, depending on the breadth and quality of the reported results.

Phillips 66 declined both requests for reports this year, on the issues of climate change and water usage. Likewise, Valero has not been an active participant either for 2015. It also declined to respond to requests for the same two reports. As a result, they were not scored on these issues, and were not given grades.

It would behoove Valero and Phillips 66 to more actively engage with the CDP. These companies could improve their public images by being more forthcoming with the CDP and their stakeholders.

 

Companies to Watch

Other, smaller refiners are also benefiting from the trend. These include:

Marathon Petroleum (NYSE: MPC). Marathon is an oil refiner, like Valero and Phillips 66. The stock has returned 17 percent year-to-date. Marathon raised its dividend by 28 percent earlier this year, and its current dividend yields 2.4 percent.

Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.

 
Originally published on December 27, 2015