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Anything and everything remotely tied to oil has been selling off hard. But the market is missing the bigger picture: some of these stocks will actually benefit from lower oil prices.
While it’s true that lower oil prices means lower profits for certain industries, it should turn out to be a big positive for industries that use oil as an input cost. One overlooked industry is the oil refiners. These companies turn crude oil into more usable liquids, such as gasoline and heating oil.
The selloff in everything oil-related has created a buying opportunity for a number of industries, but the oil refiners have a number of long-term tailwinds and offer income to yield-seeking investors.
Back in June, oil refinery stocks sold off when the federal government “tweaked” the oil export law. There’s long been a ban on oil exports from the U.S. It turned out the change didn’t really affect the major refiners and it’s been business as usual, but the stock prices didn’t recover.
Then, there’s the fact that oil prices have tumbled of late, coupled with a narrowing of the spread between WTI (West Texas Intermediate — the U.S. price benchmark) and Brent (international benchmark), which has pushed oil refining stocks even lower.
But the longer-term growth story is that the amount of oil being extracted from the U.S. shale plays is tremendous. This will result in plenty of business for U.S. refiners, while also keeping the U.S. oil prices lower than international markets.
That means the refiners will continue to buy WTI cheaply and then sell at the higher Brent prices. And assuming oil prices move higher in 2015, refiners will be even more profitable in the future.
However, many of the major oil refinery stocks are still down year-to-date.
From an income perspective, these stocks get overlooked by yield-craving investors, because their yields are only between 2% and 3%. However, their yields are still above the S&P 500 average dividend yield of 2%. The dividend yields on these stocks are the highest we’ve seen in nearly two years.
The three refiners below are not only the best investments in the industry, but they are also the largest players.
No. 1: Phillips 66 (NYSE: PSX)
Phillips 66 has 16 refineries with a 2.5 million barrel per day capacity. Phillips 66 generates nearly half of its earnings from its refining business, while its chemicals segment is another major profit driver for the company.
This refinery operator offers the highest dividend yield of the major oil refiners, coming in at 2.6%. But shares are down 11% over the last two months.
The stock’s valuation has also become enticing over the last couple months, with Phillips 66 trading at a forward P/E ratio (price-to-earnings ratio based on next year’s earnings estimates) of 10.1. Factoring in analysts’expected earnings growth for the next five years and Phillips 66’s PEG (price-to-earnings to growth rate) ratio is just 1.1—anything around 1.0 or below is considered a growth at a reasonable price stock.
No. 2: Valero Energy (NYSE: VLO)
Valero is world’s largest refiner with 16 refineries in operation. It is one of the pure plays on the refining business, which generates the bulk of its operating income. Valero’s total capacity is 2.9 million barrels per day.
Valero’s dividend yield is 2.3%. Its shares are down 10% for the last 60 days. Valero is the cheapest player in the industry, trading at a forward P/E ratio of 8. Its PEG ratio is just 0.5.
Valero will be a big benefactor from rising oil production from shale plays and Canadian oil sands. Much of that oil is going to the Gulf of Mexico to be refined and Valero is the largest Gulf Coast refiner —nine of its 16 refineries are on the Gulf Coast.
No. 3: Marathon Petroleum (NYSE: MPC)
Marathon Petroleum owns and operates six refineries in the U.S., with capacity in excess of 1.1 million barrels per day. It is another leader in the Gulf Coast refining business. About 60% of Marathon Petroleum’s capacity is located in the Gulf Coast and the rest is in the Midwest.
Marathon Petroleum offers a 2.35% dividend yield and its shares are down 6% over the last couple months. The valuation for Marathon Petroleum is also enticing, with the stock trading at a 9.4 forward P/E ratio.
All these refiners have solid balance sheets and generate impressive levels of free cash flow. Overall, the oil industry has been under pressure, but this is good news for refiners. What’s more, investors can buy up these stocks while their dividend yields are near record highs.
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