Strong Fundamentals To Aid Oil & Gas Refining & Marketing Industry

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:

• The gasoline market fundamentals, as they stand, point to steady improvement. Per the EIA, gasoline supply surplus is now gone, with inventories of the prime transportation fuel in the United States falling below the five-year average. The latest government data revealed a sizeable decline in gasoline supplies for the sixth week in a row, falling nearly 13 million barrels since the week ending Sep 20 to a 23-month low. Coupled with strong exports and steady domestic demand, crack spreads – a measure of refining profitability – have been holding up rather well. The robust crack spread is likely to drive both revenues and earnings of the sector components.

• 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 the 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.

• The protracted trade war between the United States and China has cast a pall over the gasoline demand outlook. Moreover, weak industrial growth in China – the world's second-biggest consumer of the fuel after America – is expected to keep prices depressed. As it is, the loss of Venezuela’s heavy grade oil has put U.S. refiners in a difficult position. Narrow WTI-Brent crude differentials might also weigh on margins for refining and marketing companies. This is because refined products, which are exported worldwide, use WTI crude as inputs but are priced higher than Brent.

Zacks Industry Rank Indicates Optimistic 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 #74, which places it in the top 29% 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 bullish 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.

Before we present a few stocks that you may want to consider, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Outperforms Sector But Lags S&P 500

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

The industry has declined 5.7% in the past year compared with the S&P 500’s gain of 8.8% and broader sector’s decrease of 16.2%.

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 7.86X, lower than the S&P 500’s 10.94X. However, it is significantly above the sector’s trailing-12-month EV/EBITDA of 4.73X.

Over the past five years, the industry has traded as high as 16.40X, as low as 4.44X, with a median of 7.36X.

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. The healthy refining margin environment and booming exports have also been conducive for earnings growth.

With the abovementioned catalysts set to provide near-term upside, we are presenting three stock with a Zacks Rank #2 (Buy) that are well positioned to grow. There is also a stock with a Zacks Rank #3 (Hold) that investors may currently retain.

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

Murphy USA Inc. (MUSA): This company – a leading independent retailer of motor fuel and convenience merchandise in the United States – has seen the Zacks Consensus Estimate for 2019 increase 10.7% over 30 days. Murphy USA carries a Zacks Rank #2.

Price and Consensus: MUSA

Phillips 66 (NYSE:PSX) (PSX): This diversified energy operator – with a Zacks Rank of 2 – focuses on four main business segments - refining, marketing, chemicals and storage & transportation. Phillips 66 has seen the Zacks Consensus Estimate for 2019 rise 15.6% over 30 days.

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 Zacks #2 Ranked firm has seen the Zacks Consensus Estimate for 2019 increase 4.2% over 30 days.

Price and Consensus: INT

HollyFrontier Corporation (HFC): HollyFrontier is one of the largest independent refiners and marketers of petroleum products in the United States. Carrying a Zacks Rank of 3, this company has seen the Zacks Consensus Estimate for 2019 increase 6.1% over 30 days.

Price and Consensus: HFC

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