A number of refiners recently reported strong results in their respective fourth quarters. We had been watching the group’s tremendous performance via Phillips 66 (PSX), a holding in our Dividend Growth portfolio, but let’s dig into the firm’s peers to highlight a few industry trends.
Valero
On Tuesday, Valero (click ticker for report: ) announced a “blowout” fourth quarter, with earnings growing to $1.82 from $0.08 per share, trouncing the consensus estimate. Revenue was roughly flat, so what drove such substantial earnings growth?
CEO Bill Klesse said it best:
“Also in the fourth quarter of 2012, we replaced all imported light foreign crude oils with cheaper domestic crude oils at our Gulf Coast and Memphis refineries. Since we expect U.S. and Canadian crude oils to become increasingly more available, we are pursuing options to process additional volumes of these cost-advantaged crudes throughout our refining system.”
Essentially, substituting crude from foreign producers to crude from domestic shale sources has given the domestic refiners a real cost advantage that didn’t exist previously. Even retail, a business Valero plans to exit, saw a 14% jump in operating income. Since the US shale revolution looks to have staying power, we think the cost structure of Valero’s business may be permanently lower.
Marathon Petroleum Company
Not to be confused with the other Marathon (MRO), Marathon Petroleum Company (click ticker for report: ) announced today that it swung from a loss of $0.21 per share to a profit of $2.26 per share in its fourth quarter, smashing consensus estimates. Although the company plans significant capital investment in 2013, it managed to expand its share repurchase program to $2.65 billion—on top of $1.35 billion worth of buybacks in 2012.
MPLX (MPLX), an MLP established by Marathon and now trading on the New York Stock Exchange, will be Marathon’s main avenue to generate earnings in the midstream segment.
What’s driving profitability? Much like Valero and Phillips 66 (click ticker for report: ), Marathon has managed to find lower crude inputs, which has resulted in substantial refined-product margin expansion. Here’s what the company had to say about refining and marketing margins:
“The refining and marketing gross margin averaged $9.17 per barrel and $10.45 per barrel for the fourth quarter of 2012 and full-year 2012, respectively, compared with $0.39 per barrel and $7.75 per barrel for the fourth quarter of 2011 and full-year 2011, respectively.”
Again, we see a lower cost structure going forward. Though shares have doubled over the past year, we believe the company looks fairly valued at current levels.
Hess
Hess (click ticker for report: ) is getting out of the refining business at precisely the wrong time. The business had been challenged for the past few years, but improvements in its cost structure made it profitable once again. Still, Hess will focus on its retail and marketing segment, as well as exploration and production to drive earnings. Production jumped 8% during the quarter to 396,000 barrels per day, with Bakken shale production up 68% year-over-year to 64,000 barrels per day.
The strategy was successful in its fourth-quarter report, released today, as the company swung to a profit of $1.66 per share from a loss of $0.39 per share, crushing estimates. Unfortunately for Hess, lower average selling prices will damage E&P earnings, even if production continues to rise. Hess’ balance sheet is highly leveraged, with net debt of nearly $7.5 billion. We aren’t nearly interested in the firm as we are in its refinery counterparts, and we think shares look fairly valued at this time.
All things considered, we like recent trends out of the refining sector, giving us confidence in our Dividend Growth Newsletter portfolio holding, Phillips 66. However, with shares of the firm nearly doubling in less than a year, we may exercise prudence and take a little off of the table in the coming weeks.