Refining stocks Marathon Petroleum (MPC), Valero Energy (VLO), and Phillips 66 (PSX) have plunged sharply in August. The fall is due to the crashing equity market, falling crude oil prices, and the declining benchmark refining crack.
Investing in refining stocks
So far in August, the S&P 500 Index (SPY) has slumped by 3.6%, and WTI has fallen 5.2%. The trade tension between the US and China is taking its toll on the equity and oil markets. In August, the US Gulf Coast WTI 3-2-1 benchmark refining crack has, on an average, fallen 16.9% to $17.30 per barrel.
These scenarios present an opportunity to buy growth stocks at lower valuations. To see how attractive refining stocks are, let’s evaluate their valuation and earnings prospects.
Refining stocks and valuation plunge
In August, Marathon Petroleum (MPC) has plunged the most, falling 19.6%. Lower earnings, as well as weaker equity and oil markets, have hammered MPC’s stock price. However, the company surpassed its earnings estimate for the second quarter. The fall in MPC’s stock price has beaten down its forward PE multiple to 7.3x.
Refining companies saw weaker refining margins in the second quarter. Marathon Petroleum’s gross refining and marketing margin fell $0.20 per barrel year-over-year to $15.20 per barrel in the second quarter.
Valero’s refining margin fell $1.60 per barrel year-over-year to $9.60 per barrel. Plus, Phillips 66’s refining margin fell $0.90 per barrel year-over-year to $11.40 per barrel in the quarter.
Refiners’ EPS to fall in 2019
Wall Street analysts expect refining companies’ earnings to fall in 2019. While analysts expect Marathon Petroleum and Valero’s earnings to fall 29% each, they expect Phillips 66’s earnings to fall 33%. This lower earnings estimate is driven by a lower refining margin and earnings estimate for the year.
Analysts expect refiners’ earnings to rise in 2020
Analysts expect these companies’ earnings to rise in the next year, as they expect refining conditions to improve. Plus, analysts expect Valero’s earnings to increase 84% in 2020. Also, they expect Marathon Petroleum and Phillips 66’s earnings to increase 73% and 32%, respectively, next year.
Marathon Petroleum’s growth activities, including the acquisition of Andeavor, has taken the company on a steep growth trajectory. Valero, with its capex activities and comfortable debt position, is well-placed to support its future earnings. Plus, Phillips 66 has diversified an integrated, growth-oriented earnings model to its advantage.
A consolidated scenario for 2019 and 2020
So, with an estimated fall in earnings in 2019 and a subsequent rise in 2020, it makes sense to look at the consolidated earnings growth of refining stocks for the next two years.
With respect to consolidating earnings growth, analysts expect Valero to post the highest increase of 32% from 2018 to 2020. Valero has a series of ongoing projects that could add to its earnings growth.
The company expects to see an incremental annual EBITDA of about $1.2 billion–$1.5 billion by 2022 from its growth projects. Valero expects to spend around $1 billion annually on growth projects until 2021. With less debt in its capital structure, Valero has the financial health to continue its growth ventures.
Further, analysts expect Marathon Petroleum’s earnings to rise 22% in the same period, the second-strongest trend among these companies. Marathon Petroleum has been expanding via capex and acquisitions. The company’s latest addition, Andeavor, has enlarged its capacities and network. So, Marathon Petroleum could profit not only from merger synergies but also from growth projects.
However, analysts expect subdued performance from Phillips 66 in the next two years. They expect Phillips 66’s earnings to fall 11%.
In our view, the recent slump in refining stocks provides investors with the right opportunity to invest in well-placed stocks. Valero, with the highest growth of 32% over the next two years, looks like an attractive investment option. The stock also has a 4.6% dividend yield. The next-strongest stock in the group is Marathon Petroleum, with 22% growth over the next two years.
Maitali Ramkumar holds no positions in MPC, PSX, or VLO.