Oil refining is a notoriously cyclical business. Tropical abundance deteriorates to lunar barrenness, and then revives to tropical abundance once again.
Today, I see more of a lunar landscape than a tropical one.
Refiners have struggled of late. HollyFrontier (NYSE: HFC) is one of the strugglers. Its share price has been halved in the past year.
HollyFrontier is a smaller independent refiner. It predominately refines oil into gasoline, diesel fuel, jet fuel, and specialty lubricants. It performs this refining alchemy at five major refineries dotted across the Midwest.
As so often occurs in cyclical industries, the news – for good or bad – trends in one direction for a time, until it doesn’t. For the past year, most of the news has trended badly, and that badly trending news has weighed on HollyFrontier’s share price.
Where to begin?
HollyFrontier is highly exposed to gasoline production: 53% of its total refining yield in the first quarter was related to gasoline. Gasoline profit margins have dropped to their lowest seasonal level since 2010. High imports have kept gasoline inventories high, even as demand rises heading into the summer driving season.
Refining earnings are sensitive to the crack spread – the spread between the cost of a barrel of oil and the products refined from that oil. The spread has mostly contracted over the past 12 months.
HollyFrontier’s business has been further hampered by elevated ethanol costs. Refiners are mandated to oxygenate gasoline. Ethanol is commonly used to oxygenate gasoline in the Midwest. Last month, ethanol prices hit a six-month high.
Recent financial performance has hardly provided relief. Gross refining profit margins were cut in half year over year to $7.59/barrel from $16.99/barrel. EPS for the latest reported quarter posted at $0.12 compared to $1.16 a year earlier (and this is after reporting a $0.26-per-share loss in the fourth quarter of 2015).
The drop in HollyFrontier’s share price has elevated its dividend yield to 5.5%. I like the yield and I like the entry price. Both are enticing because the news trend appears to be reversing.
Management was upbeat during the May earnings call. Management was sure to remind everyone that April gasoline crack spreads in its regions have increased by 40% to 70% from first-quarter levels. Managements expects crack spreads to continue to strengthen into the summer driving season. Recent Bloomberg data support management’s optimism. The crack spread jumped 12% in June.
Cash should flow more profusely in the future. HollyFrontier targets $700 million of incremental annual EBITDA by 2018. Management assures us that its on target to achieve $200 million in incremental EBITDA this year.
More good news is found in the price recovery of Holly Energy Partners (NYSE: HEP), a pipeline and storage MLP. HollyFrontier owns 39%, or 22.4 million, of Holly Energy’s outstanding units. These units are up over 40% since mid-February. Holly Energy is a goose that continually lays golden eggs. Holly Energy pays HollyFrontier over $51 million in distribution income on its units annually. This amount rises year after year. Holly Energy has a long history of distribution growth.
While waiting for the good-news trend to take over, investors can take comfort in knowing that HollyFrontier remains sufficiently liquid to buy back shares and maintain its dividend. In the first quarter, HollyFrontier repurchased 3.7 million shares. The company has $179 million more to spend on an existing share-repurchase authorization. The $0.33 per-share quarterly dividend was also affirmed.
The big dividend, the low share price, the continual share buybacks, and the prospect of more good news all point to a HollyFrontier revival sometime in 2016.