VLO - U.S. Refiners: Earnings Review And Outlook

2023-05-15 02:04:09 ET

Summary

• In the last few weeks,  U.S. refiners reported results with all beating earnings estimates and 75% beating revenue estimates.
• Despite solid results, U.S. refiners declined about 15% over the last month.
• Over three years, U.S. refinery capacity has trended down while utilization remains near historic highs.
• Crack spreads are expanding as oil declines and gas prices remain high.

Recent Quarterly Results

Just before U.S. refiners began reporting earnings, I published a review of the sector entitled Refining Sector Earnings Trends And Expectations . Based on high refinery utilization rates, growing crack spreads, and low analyst expectations, I expected most refiners to beat analyst estimates.

Recent Earnings vs Estimates

Estimated earnings are plotted with dashed columns while actual earnings are plotted with shaded blue columns. Each blue column is annotated with the percentage by which results beat estimates. Every single refiner beat estimates by at least 6%. In fact, the refiners reported earnings that beat estimates by an average of 21%.

Recent Revenues vs Estimates

Estimated revenues are plotted with dashed columns while actual revenues are plotted with shaded green columns. Each green column is annotated with the percentage by which results beat estimates. Seven out of eight refiners met or beat estimates with the group beating revenue estimates by about 9%.

How Did The Market React?

Perhaps investors will not be surprised, but U.S. refiners are down about 15% over the last month. The industry's momentum may be even more compelling.

Momentum

Most refiners are below their simple moving averages over every interval with some rallying modestly over the last 10 days. Let's take the largest refiner by market cap, Marathon Petroleum Corporation ( MPC ), and look at a plot of simple moving averages over time.

MPC Momentum

Note, price is below 10D SMA and well below 50D, 100D, and even 200D SMA. Further, even though price has recently rebounded somewhat, 10D SMA remains at a short-term low.

At certain times, I would interpret a momentum plot like this as a positive indicator of and predict an impending upswing. However, investors are advised not to look past recent energy sector or broader market sentiment around recession, banking instability, and inflation etc.

Refining Sector Outlook

Future refining sector earnings and revenue are supported in part by falling refining capacity and high utilization rates.

Refining Capacity & Utilization

Over the last three years, refining capacity has generally trended down while utilization has trended up reaching a historic high of over 95% recently. More recently, utilization has retreated below 90% but refineries are finnicky operations with shut downs for periodic maintenance and somewhat frequent upsets.

The dashed portions of the capacity and utilization lines reflect the most precarious type of upset, a refinery fire. On May 5th, an explosion was followed by a fire at Shell Plc's ( SHEL ) Deer Park, Texas chemical plant with nine hospitalizations. Note, PEMEX acquired SHEL's adjacent Deer Park refinery in 2022 and that operation, so far, does not appear to be impacted. The dashed lines represent shutdown of 50% of the refining capacity of the entire Deer Park complex and should most correctly be interpreted as only a possibility.

None the less, the recent Deer Park fire serves as a reminder that high refinery utilization represents a moat around refiner revenues and earnings. Although refiners' share price often move in parallel to the broader energy sector and commodity prices, refining margins can expand as commodity prices fall if the price of refined products like gasoline remain elevated. The industry term crack spread refers to the difference in the cost of refining inputs including oil and the price of outputs including gasoline.

Crack Spread

The crack spread plot above was recently published by U.S EIA , red annotations are by the author. So far, 2023 crack spreads exceed not only the five year range but also record 2022 values. Note, crack spreads tend to increase in the upcoming summer months.

Falling Valuations

The sum total of growing earnings on wider margins and falling prices on broader sentiment is more favorable valuations.

PE TTM is plotted over the last year for the six largest U.S, refiners by market cap. Everyone is currently cheaper than at any time in the last year. However, relatively favorable valuation is not sufficient to make any final decision.

Leaves In The Wind

I spend perhaps too much time thinking about the stock market and apply many metaphors in my continuing pursuit of understanding. One of my favorites is leaves in the wind. Generally speaking most leaves will move in the general direction of the prevailing wind. Still, some leaves on chance, density, surface area, or shape will be carried along more quickly than others. Some may even get caught in a back eddy and move counter to the wind.

The leaves in this case are U.S refining sector stocks with wind gusts arising from energy sector sentiment, commodity prices, crack spreads, and more broadly sentiment surrounding the U.S stock market and economy. The prevailing wind appears to be poor sentiment and outlook; profitable refiners with low valuations could get even cheaper.

I'm looking for an opportunity to buy a profitable refiner very cheap. I will follow up with a matrix evaluation of the U.S. refiners to determine the relative quality of the leaves. Finally, I will individually evaluate those leaves that appear to be the most compelling. I might find one leaf on whose trajectory I'm willing to bet. Stay tuned.

Is there such a thing as a cheerful pessimist? That's what I am. - Charlie Munger

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