Coronavirus Hits Oil & Gas Refining & Marketing Industry Demand

The Zacks Oil and Gas - Refining & Marketing industry consists of companies that are involved in selling refined petroleum products (including heating oil, gasoline, residual oil, etc.) and a plethora of non-energy materials (like asphalt, road salt, clay, and gypsum). Some of the companies also operate refined products terminals, storage facilities and transportation services. The primary activity of these firms involves buying crude/other feedstocks and processing them into a wide variety of refined products.

Let’s take a look at the industry’s three major themes:

• Since the last Industry Outlook, U.S. inventory data has shown healthy supply build for gasoline and distillate inventories, signaling plenty of oil products in the market. Therefore, margins continue to remain depressed despite robust demand. Further, the deadly novel coronavirus (COVID-19) outbreak has weakened demand from the world’s largest energy consumers. In particular, with major cities under lock-down and travel restrictions in place, the consumption of jet fuel (a derivative of distillates) is set to drop substantially. This will not only affect refining profitability but also result in increased price volatility.

• Oil prices fell below $30 a barrel last week for the first time in four years as tensions between Russia and Saudi Arabia combined with continued panic over the spreading coronavirus sent the commodity crashing. While realizations for gasoline and heating oil have gone down too, the rate of decline has been slower. This is because beaten down prices of refined products leads to higher demand. In other words, refining margins are likely to improve with a dip in prices for its raw material, i.e. crude oil.

• The downstream refining and marketing companies tend to get a major portion of their cash flows from gasoline distribution and retail operations. These businesses are quite stable and defensive thanks to highly inelastic gasoline sales and demand. Consumption of gasoline is a necessity and remains resilient even during lean times as consumers would still need to drive and fill up the tank. In fact, the current low oil price environment influences people to drive and travel more, which boosts gasoline demand. Lower fuel expense also leaves consumers with a larger disposable income that they can utilize on retail store purchases.

Zacks Industry Rank Indicates Grim Outlook

The Zacks Oil and Gas - Refining & Marketing is a 13-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #202, which places it in the bottom 20% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dim near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic on this group’s earnings growth potential. As a proof of this, the industry’s earnings estimate for 2020 have decreased 33.5% in the past year. Meanwhile, the same for 2021 have slumped 32.7% over the trailing 12-month period.

Despite the bleak near-term prospects of the industry, we will present a few stocks that you may want to consider for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.

Industry Lags Sector & S&P 500

The Zacks Oil and Gas - Refining & Marketing industry has lagged the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.

The industry has declined 55.2% over this period compared with the S&P 500’s loss of 5.2% and broader sector’s decrease of 51.6%.

One-Year Price Performance

Industry’s Current Valuation

Since oil and gas companies are debt laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of noncash expenses.

On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA), the industry is currently trading at 5.06X, lower than the S&P 500’s 10.05X. However, it is well above the sector’s trailing-12-month EV/EBITDA of 3.63X.

Over the past five years, the industry has traded as high as 16.47X, as low as 4.34X, with a median of 7.39X.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio

Bottom Line

The traditional fuels refining operation — where crude is turned into products ranging from gasoline and diesel to jet fuel and asphalt — is heavily dependent on commodity price fluctuations. A tepid oil price environment generally results in the strengthening of crack spreads (or the difference between the price of oil and refined products).

Therefore, given the current weakness in oil (the input for refiners), demand is expected to be strong due to low product prices. This, in turn, will bolster cash flow generation at the companies with downstream exposure.

However, the health scare and the resulting economic uncertainty caused by the coronavirus have led to fears of lesser driving worldwide, translating into lower oil product demand. Consequently, the freed-up domestic barrels could find their way to the export market and weaken the fundamentals.

Despite the current downbeat mood in the industry, we are presenting four stocks with a Zacks Rank #3 (Hold) that investors may currently retain in their portfolio.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Murphy USA Inc. (MUSA): This company is a leading independent retailer of motor fuel and convenience merchandise in the United States. Murphy USA has an expected earnings growth of 7.7% for this year.

Price and Consensus: MUSA

Phillips 66 (NYSE:PSX) (PSX): This diversified energy operator focuses on four main business segments - refining, marketing, chemicals and storage & transportation. Phillips 66 has an expected earnings growth of 7.3% for this year.

Price and Consensus: PSX

World Fuel Services Corporation (INT): World Fuel Services is engaged in marketing and selling marine, aviation, and land fuel products, plus associated services. The downstream operator has an expected earnings growth of 2.5% for this year.

Price and Consensus: INT

PBF Energy Inc. (PBF): PBF Energy provides end products that comprise heating oil, transportation fuels and lubricants among others. The company has an expected earnings growth of 338.9% for this year.

Price and Consensus: PBF

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