HollyFrontier (HFC) is an out of favor oil refiner whose stocks has collapsed by 50%. However, according to Morningstar, there should be a lot to like for patient and contrarian investors. In addition, the current yield of 5.2% allows investors to generate above average income while waiting for oil markets to improve.
HFC is among the largest independent refiners with operations in the Midwest, Southwest and Rocky Mountain regions. HFC operates five large refineries producing gasoline, jet fuel, asphalt, heavy oil and lubricant products. 53% of recent production is gasoline. HFC has current capacity of 457,000 barrels of processing per day, and is planning on expanding its capacity to over 500,000 barrels. Similar to its peers, HFC has been dropping down terminal and pipeline assets to a MLP, Holly Energy Partners (HEP). HFC is the General Partner and owns 39% of HEP outstanding shares.
While the refining segment has been weak in operating profits from a substantial drop in crude prices, a shrinking of crack spreads, and a buildup of gasoline and finished products, HFC has historically out earned many of its peers. Comparing a list of operating profit per barrel of crude refined for its peers from 2011 to 2015, as offered on their investors presentation, HFC has generated first class operating profits per barrel. Its 5-yr average profit per barrel is best of its peers. In 4 of the last 5 years, HFC has been either #1 or #2 in profitability.
At 17%, HFC also excels in generating returns on invested capital. HFC bests its peer 5-yr average of 13% by 30%, and is second only to Western Refinery’s 19%. Even in today’s tough operating environment, HollyFrontier continues to generate operating results that exceeds its peers.
One important advantage for HFC is the complex nature of its refinery assets allows the firm to utilize lower cost heavy sync crude from the oil sands. HFC’s complexity ratings is 12.1, on a scale of 1.0 to 14.0, with a US average refinery complexity of 9.0. For investors, this means that HFC operates one of the most complex and potentially profitable chains of refinery assets in the US. The higher complexity factor allows HFC to refine lower grades of crude into gasoline and diesel, potentially expanding comparable margins. When the oil market returns to more normal pricing, HFC’s profitability should improve.
Morningstar rates HFC as 5 Star with a price target $47, and believes HFC is trading at a 45% discount to its fair value. M* is looking for West Texas crude to average $50 in 2017, $65 in 2018, and $60 in 2019. This pricing level for WTI will support higher profits for HFC. While many Gulf Coast refiners rely on water-borne oil for supply whose pricing reflects the Brent price collar, the mid-continent locations of HFC refineries allow the firm to utilize WTI priced crude. The spread between Brent and WTI (with WTI lower) can be as much as $5, giving HollyFrontier a distinct cost advantage in a low margin, commodity business. HFC’s ability to utilize both sync crude and WTI will continue to allow the company to operate with one of the higher profits per barrel of throughput.
HFC announced its second quarter earnings at a loss of -$2.33 per share after non-cash charges for impairment of goodwill and asset write-downs. Before the $650 million of charges, HFC earned $0.28 a share for the qtr. For 2015, HFC earned $3.90 a share and is expected to earn between -$0.68 and $1.07 (after and before charges) in 2016, $2.19 in 2017, and $3.08 in 2018. The upcoming 3rd quarter historically has been the best of the year, followed by the 4th which is the worst of the year.
The dividend of $1.34 offers a yield of 5.3% and is qualified. Investors should note the dividend was cut by 60% in early 2015 due to the weak commodity environment. The dividend is supported by operating cash flow in excess of $720 million over the previous 12 months and $533 million in cash on the balance sheet.
HollyFrontier has a current book value of $27.80 and trades at a 6% discount to BV. The 5-yr average price to book value is a 30% premium, which would represent a share price in the high $30s.
Investors looking to stretch for higher yield and willing to accept a higher risk over the short term may consider HFC. While rated only B (Below Average) for 10-yr consistency in earnings and dividend growth, the prospects of a turnaround in profitability leading to higher share prices combined with a comfortable current yield should offset a lack of dividend growth.
Thanks for reading and this article was first published in the Sept issue of Guiding Mast Investments. George Fisher