2023-10-04 15:57:24 ET
Summary
- HF Sinclair Corporation has benefited from sky-high refining margins due to the Ukrainian crisis, resulting in record earnings and strong performance.
- The company has an exemplary management, which has made strategic acquisitions and has maintained a strong balance sheet.
- While HF Sinclair Corporation stock may appear undervalued based on current earnings, it appears fairly valued based on normal earnings.
Just like all the refiners, HF Sinclair Corporation ( DINO ) has greatly benefited from the Ukrainian crisis. Thanks to the sky-high refining margins that have resulted from the war in Ukraine, the company posted record earnings last year and is on track for the second-best performance in its history this year. The stock is currently trading at a forward price-to-earnings ratio of only 5.4x . The extremely low earnings multiple may lead some investors to think that the stock is grossly undervalued. However, as refining margins are infamous for their cyclicality, HF Sinclair Corporation stock seems to be fairly valued right now.
Business overview
Just like all the U.S. refiners, HF Sinclair incurred excessive losses in 2020 due to the coronavirus crisis, which caused a collapse in the global demand for oil products. However, thanks to the reopening of the global economy, the company recovered strongly in 2021.
Even better, HF Sinclair has greatly benefited from the Ukrainian crisis. Shortly after the invasion of Russia in Ukraine in early 2022, the U.S. and the European Union imposed strict sanctions on the exports of refined products from Russia. As this country provided 10% of global oil output and an even greater share in the global markets of diesel and gasoline, refining margins skyrocketed to unprecedented levels last year. As a result, HF Sinclair posted record earnings per share of $14.73 last year. To provide a perspective, the previous record of the company was earnings per share of $6.44 in 2018.
Refining margins somewhat moderated off blowout levels in the first half of this year but they remained far above normal levels. As a result, HF Sinclair reported earnings per share of $4.40 in the first half of the year and is expected by analysts to achieve earnings per share of $10.06 in the full year. If the refiner meets the analysts’ consensus, it will post the second-best earnings per share in its history.
It is also important to note that HF Sinclair is one of the highest-quality refiners in the country thanks to its exemplary management. Some oil companies, such as Exxon Mobil (XOM), curtailed their growth projects in 2018-2021 in order to keep offering generous dividends. On the contrary, HF Sinclair suspended its dividend for one year and issued some shares in order to fund two highly profitable acquisitions.
In late 2021, the company acquired the Puget Sound Refinery from Shell ( SHEL ) for $350 million. In addition, in early 2022, the company acquired Sinclair Oil and thus it added two refineries, a renewable diesel business, and a branded marketing business to its business portfolio. It is needless to say that the timing of these acquisitions was ideal, as refining margins skyrocketed shortly after the deals and have remained above average since then. Therefore, these two deals have offered outsized returns on investment so far.
On the other hand, investors should not expect the exceptionally high refining margins to remain in place for years. The refining industry is infamous for its dramatic cyclicality. During periods of wide margins, some refineries invest in the expansion of their capacity while some new refineries are built as well. Consequently, global refining capacity increases, and thus it leads refining margins to lower levels, especially if the global economy decelerates or falls into a recession.
Notably, the U.S. refining margins have contracted by approximately 30% during the last month, from about $29 per barrel to $20.2 barrel. This is their lowest level since January 2022, just before the onset of the war in Ukraine. The current refining margins are somewhat higher than the average refining margins of about $18 per barrel in 2018 and 2019, but the tailwind from the Ukrainian crisis seems to have abated. The steep correction is somewhat surprising, given the heavy seasonal maintenance activity of refiners, which normally provides support to refining margins. Moreover, as the sharp correction of refining margins is very recent, it is hard to forecast at what level margins will stabilize.
Overall, the tailwind from the sanctions of western countries on Russia seems to be fading. Indeed, analysts expect the earnings per share of HF Sinclair to decrease by 31% next year and by another 15% in 2025, from $10.06 this year to $5.91 in 2025.
Dividend – Balance sheet
HF Sinclair is offering a 3.3% dividend yield. The stock has a payout ratio of only 14% , and hence its dividend has a wide margin of safety, despite the cyclical nature of its business.
It is also important to note that HF Sinclair has one of the strongest balance sheets in the energy sector. Its net interest expense consumes just 4% of its operating income, and its net debt (as per Buffett, net debt = total liabilities – cash – receivables) is standing at $3.3 billion. This amount is less than twice the annual earnings of the company and only 32% of its market capitalization, and hence it is easily manageable.
The strong balance sheet of HF Sinclair is paramount, as it helps the company easily endure the fierce downturns of the refining industry that occur every few years. It also enables the company to perform highly profitable acquisitions during opportune times, such as the two acquisitions mentioned above.
Valuation
HF Sinclair is currently trading at an extremely low forward price-to-earnings ratio of 5.4x due to its blowout earnings this year. As the earnings of the company are abnormally high this year, they are not suitable for the evaluation of the stock.
The earnings per share of $5.91, which are expected by analysts for 2025, can be considered much more sustainable and hence they can be used in the evaluation of the refiner. The stock is currently trading at 9.2x times its expected earnings in 2025. This valuation level is somewhat lower than the 10-year average of 10.3x of the stock. Therefore, the stock appears slightly undervalued right now.
On the other hand, it is prudent to keep in mind that refiners are facing a long-term threat due to the exponential growth of the sales of electric vehicles and the unprecedented number of green energy projects that are being developed in response to the energy crisis experienced last year. Whenever all their renewable energy projects come online, they will probably take their toll on the global consumption of fossil fuels and hence on refining margins. Overall, HF Sinclair appears fairly valued around its current stock price.
Final thoughts
HF Sinclair has been thriving in the last two years, primarily thanks to the tailwind from the sanctions of western countries on Russia. In addition, the company is characterized by exemplary management, which does its best to enhance long-term shareholder returns by focusing on the factors of the business it can control. However, the refining business is highly cyclical, with its cycles being out of the control of the company. Therefore, it is prudent for investors to expect refining margins to revert to normal levels in the upcoming quarters. Overall, HF Sinclair Corporation stock appears fairly valued right now.
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HF Sinclair Appears Fairly Valued Right Now