Portfolio Review: Refiners and Big Oil

In the previous two articles, I reviewed the oil and natural gas producers in the portfolio. Today, I will review the two refiners and the two integrated supermajors that are in the portfolio.


First, here are all of the publicly-traded U.S. refiners, along with some key metrics for each company, in order of descending enterprise value:

  • EV – Enterprise value at the close on October 20, 2017
  • FCF – Free cash flow
  • TTM – Trailing twelve months
  • EBITDA – TTM earnings before interest, tax, depreciation, and amortization
  • Debt – Net debt at the end of the previous fiscal quarter
  • 1 Yr Ret – Twelve-month total shareholder return (including dividends) through October 20, 2017 

I have noted in many articles that despite the overall downturn in energy since mid-2014, the refining sector has excelled. In fact, over the past three years, the refining group has outperformed not only the rest of the energy sector but the broader market indices as well. Notably, over the past year, every refiner in the table above generated positive shareholder returns. 

There are a number of good choices among the refiners, and we have held many among this group at various times. At present, two of these refiners remain in the portfolio. 

Valero (NYSE: VLO) was most recently added back to the portfolio on August 21st, 2017 (See Valero is a Value), and has returned 20% since.

Valero processes more crude oil globally than any other independent petroleum refiner. Over the past year, Valero produced more cash flow and EBITDA than any of its competitors. Nevertheless, when compared to its peer group of refiners, Valero has less relative debt, a higher yield, and a lower EV/EBITDA ratio. The dividend has grown for six straight years, and the current yield of 3.6% has room to grow with a payout ratio of only 68%. 

Valero is currently just over 10% above the $70 Buy limit I placed on shares back in August. The company is elite among the refiners, and it remains cheap. This isn’t a huge concern for long-term investors, but short-term traders may find a cheaper entry point in coming months, especially with oil prices on the rise (which is generally a drag on earnings for refiners). 

Marathon Petroleum Corp (NYSE: MPC) is the other refiner in the portfolio, added back most recently a year ago this week. Marathon is like Valero in many ways. Both companies have benefited tremendously from Gulf coast refineries that have enjoyed a finished product export boom to markets in Latin America. Like Valero, Marathon has performed well (up 32% since being added back) and is above the $55 Buy limit.  

I don’t think you can go wrong with either company, but I would still favor Valero because its financial metrics are just a bit better than Marathon’s. Arguments can also be made for other refiners on the list, but in most cases, some caveats are in order.

Big Oil  

There are five publicly-traded integrated supermajors, which we often think of as “Big Oil.” Two of those companies are in the portfolio. Here are all five, along with some key metrics for each company, in order of descending enterprise value:

  • EV/Res – Enterprise value divided by the total proved reserves in barrels of oil equivalent at year-end 2016

This group did well as a whole, but ExxonMobil was an outlier, turning in the only negative performance over the past year. That’s probably because in 2016 — for the first time in 22 years — ExxonMobil failed to find as much new oil as it produced.

The company also posted the deepest reserves cut in modern history, removing 3.5 billion barrels of oil sands in western Canada from its books. (However, I would note that ExxonMobil shares are starting to become undervalued relative to its peers).  

Chevron (NYSE: CVX) is an industry bellwether, and it has been in the portfolio for years. Since upgrading it from a Hold back to a Buy on March 23, 2017, shares have returned 12.1%.

At the time of the upgrade, I noted that Chevron was about to harvest the fruits of some significant capital expenditures on megaprojects that are now mostly behind them. As spending on these projects wound down, from 2015 to 2016 Chevron’s cash flow improved by nearly $10 billion, and almost broke even last year despite the challenging environment. 

Chevron has outperformed ExxonMobil for the past one-, five-, and ten-year periods, as well as year-to-date (YTD). The company has returned 21.8% to investors over the past year and currently yields 3.6%. I consider Chevron to be one of the safest ways to play the energy sector for conservative investors. 

The other portfolio company, BP (NYSE: BP), is a special situation. BP is not a company I would have invested in ten years ago, but it became a compelling value in the aftermath of the 2010 Deepwater Horizon oil spill. Investors fled the company as it became clear that the accident would be incredibly expensive. BP’s brand may never fully recover from the incident, but shares fell too far given the value of the company’s assets. 

This is apparent when you consider the company’s enterprise value (EV) relative to the company’s reserves. BP is the only supermajor with an EV/reserves ratio below $10 per barrel of oil equivalent (BOE). That’s why I have long argued that a larger competitor like ExxonMobil might be interested in acquiring BP. It would be a large bite to swallow, and there would be government opposition, but a BP acquisition would get a company cheap reserves and a huge downstream operation. 

BP’s Deepwater Horizon liability will continue to weigh on shares, but the uncertainty about the magnitude of the damages is largely gone. Shares won’t stay this cheap forever, but it may take some patience before the value is finally unlocked. This isn’t the same kind of play as Chevron; there is definitely more risk involved with BP. But the reward could be significant for patient investors. 

In summary, my ranking of the refiners in the portfolio would look like this:

  1. Valero
  2. Marathon Petroleum 

My ranking of the supermajors would look like this:

  1. Chevron
  2. BP

All of these are suitable for investors looking for growth or income, but conservative investors should probably stick with Chevron over BP. 

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