Valero is the largest refiner in the US and unlike an integrated oil company; their primary business is refining and marketing gasoline, distillate fuels and other products refined from crude oil.

Some investors might think that with gasoline prices skyrocketing, refiners should be making money hand over fist. But they have to contend with the crude oil prices, and those prices have been rising even faster.

This chart shows why VLO and other refiner stocks haven't been performing well. I compared weekly US gasoline price records from the US Dept. of Energy with the United States Oil (USO) ETF as a proxy for crude prices. Both prices are indexed to 100 as of 12 Apr '06. Nothing special about that date, it's just how far back the USO price goes.

The problem with refiner earnings is clear. For the first half of 2007, gasoline prices rose faster than crude oil prices expanding the crack spread, or margin between crude and refined products. From about June of last year, crude has been rising quite a bit faster than gasoline narrowing the crack spread and putting a crimp on refiner profits.

VLO looks cheap with a PE of 7.8 on estimated 2009 earnings, price-to-sales ratio of .24 and 1.4 times book value. They pay a dividend which yields 1.2% based on today's closing price. However, it's likely analysts don't have the full impact of $130 crude oil in their earnings models. VLO does have some advantage over its competitors since they have a significant capability to handle less expensive sour crude as an input.

I believe market conditions going forward will continue to squeeze US refiners. Even though US gasoline demand is down slightly, growing consumption in China, India and other growing economies is keeping world demand high. That leaves Valero and their competitors facing a US market where it is difficult to raise gasoline prices fast enough to keep up with rising crude prices.

I did hear an interview with an analyst who thought some of the refiners could be buyout targets because the market caps were below the cost of building the plant and equipment. Sorry, don't recall the name of the source.

VLO is less than 10% off its 52-week low and I don't think it has much downside. But I also don't see an economic environment supporting wider crack spreads any time soon. And with higher prices starting to impact consumption, revenue may taper off going forward.

In summary, I thought refiners were dead money when Tesoro was the question of the week last month. Nothing's happened to change my mind.

References:
a) Valero Investor Relations Industry Fundamentals Page
b) Energy Information Administration Retail Price Data

Comments: View Comments |  Thursday May 29, 2008

As you've no doubt heard, Belgian brewing giant InBev is reported to be interested in buying Anheuser-Busch for somewhere around $65 a share. Neither company has confirmed the reports, so at this stage it's somewhere between rumor and a possibility.

Last week, BUD had a sizeable gain with a big gap higher at Friday's open on the reports. Today the stock held and added a little to Friday's gains, closing at $56.75. That puts it at a PE of 17.25 on estimated 2009 earnings.

I hold BUD both in SLO and real life and wanted to take a little closer look at the risk-reward and evaluate whether to hold, take some off the table or sell it all.

The potential upside is pretty easy. Barring an unlikely bidding war, the reports I've seen all say InBev is considering a $65 a share offer. So, from today's close there's another $8 a share or so of upside if the deal goes through.

The downside is a little tougher. The BUD buyout rumor has been floating around for some time, so there's no easy way to determine how long there's been a buyout premium in the stock. The stock hit a 52-week low of $45.55 in mid-March.

One reasonable approach to determine a current fair market value is to compare BUD to some companies that have similar characteristics, even if they're not in the same business. For this comparison I looked for companies that are well established and well known, have a relatively high dividend, have some risk of raw materials inflation, with moderate predicted growth and have a business model that isn't very sensitive to the economy.

Candidate benchmarks were McDonalds (MCD), Proctor and Gamble (PG), Kellogs (K), and Kraft (KFT).

Applying these four PE's to BUD's 2009 estimated earnings produces a market value range of $51.50 to $55.20. With a lower projected growth rate, BUD should trade at a discount to MCD and PG and in the same ballpark as K or KFT, so a reasonable fair market estimate is $51 - $52 a share. That puts the downside risk target somewhere between about $46 (recent low) and $52 a share.

For my IRA account the decision was pretty simple. My model for retirement assumes steady, moderate gains, so when a holding increases about 12% in less than a quarter, I need a compelling reason NOT to take some of the profits. In this case, I sold a third of the BUD position. If the buyout materializes, I will have made a nice profit on the third I just sold and a great profit on the remaining two-thirds. If it falls apart, I should be able to repurchase the shares quite a bit cheaper and continue happily collecting dividends. Either way, BUD should easily carry its share of the load this year. Sidebar - It's nice having a beer company pay me for a change.

For SLO, the decision was tougher. There's no real risk here and BUD offers nearly 15% upside IF the InBev deal materializes before the game ends. I have already sold some of my SLO position into the run-up and now it's tempting to buy it back and play for a big hit. However, I entered this competition to practice portfolio management and am going to take the same approach in the game. Take some profits now; buy back if there's no deal.

Any other BUD holders out there? Curious to know how others are playing these rumors.

Comments: View Comments |  Tuesday May 27, 2008  |  Stocks: bud,

Chevron broke out over $100 a share last Friday and held triple digits through this week. Breaking that nice, round number seemed like a good time to do a recheck on the stock value to see whether I should trim my holdings, add more or stand pat.

Last quarter, CVX earnings beat estimates by 7 cents a share on strong oil pricing. Nearly all the profits were from the upstream, or oil production, side of the business. Downstream operations, refining and marketing, only kicked in $252 million of the over $5 billion of profits.

On a fundamental basis, CVX looks cheap. It trades at a fwd PE of 9; a little cheaper than XOM and a little more expensive than COP. They have about $2 billion of net cash. CVX pays a dividend, current yield is 2.5%. The big unknowns are whether oil prices will continue to climb or pull back and, if oil prices pull back, will refining crack spreads widen so the downstream ops start adding more than token earnings?

Using USO as a proxy for oil prices, oil is about 32% higher at the mid-point of this quarter than it was last quarter. Analyst estimates for next quarter's earnings average 2.91 a share, 17.3% above last quarters 2.48. Future oil price predictions are all over the map. Some argue crude is in a speculative bubble and will pull back to under $100 a barrel. T. Boone Pickens is predicting oil will hit $150 this year. I certainly don't know where prices will be later this year, but given the higher oil prices so far this quarter I think there's a good chance CVX will beat earnings again next quarter.

I'm inclined to hold what I've got both in SLO and real life. Basically, the stock is performing well and doesn't look overvalued, but it's hard to justify chasing it higher.

The bull case boils down to the stock selling at a low multiple with a good chance of continuing earnings beats. The stock price also hasn't risen as fast as crude prices over the past several months, so even if oil does pull back, the stock price should hold up pretty well. The bear case boils down to the stock having a strong run since last fall and taking profits makes sense. After the fast run-up in crude prices, a pullback could still drag oil companies down with it.

Feel free to add a comment with your thoughts. Are oil companies still looking good or is it time to take the money and run?

Comments: View Comments |  Saturday May 24, 2008  |  Stocks: CVX,

Carl Icahn has decided to try and shake things up after Yahoo rejected Microsoft's takeover bid a little over a week ago. According to this Marketwatch report, Mr. Icahn has accumulated 50 million shares of YHOO and is mounting a proxy fight for control of the board of directors.

Presumably, Carl plans on restarting negotiations with MSFT to complete a sale. Good call to all who figured that the market overreacted on the apparent death of the deal. For the rest of us, it may be worth evaluating whether or not playing 'follow the leader' makes any sense.

First, I think it's safe to assume the upside is limited to $33, Microsoft's last offer. They made it pretty clear they weren't going to pay up beyond that for YHOO. Given all the press hype and shareholder anger, they might not even be willing to go that high anymore.

Next, I'd want to try and establish a downside to the trade. A reasonable floor would be Yahoo's value if there weren't anyone interested in buying the company. To get that, I compared YHOO to GOOG's valuation. For a quick and dirty, I used the PE multiple based on estimated 2009 earnings for the two companies. GOOG closed today at $576.30, 23.3 times estimated 2009 earnings of $24.74 a share. Estimated 2009 earnings for YHOO are 56 cents a share. Applying GOOG's 23.3 multiple results in a comparable value for YHOO of only $13 a share. And GOOG has a higher estimated earnings growth rate, so YHOO should trade at a discount to GOOG. $13 is a far cry from todays after hours where YHOO finished at $27.65. Unless I've missed something (always very possible), the market is currently putting more than a 100% premium on YHOO to account for a possible buyout.

Between the MSFT buyout blowup and today's close, YHOO has traded between the mid 23's and about 27. It's safe to assume Icahn acquired his shares somewhere in that range. The mid-point is in the low 25's. That's important, there's something like $2.50 a share difference between Icahn making a profit and anyone who bought in the after hours making a profit.

This isn't the type of trade I'm interested in getting involved with, even with play money. In this case, the risk-reward ratio looks backwards. In the best-case scenario, the upside is a little over five bucks a share. If it blows up, the downside could be over fourteen a share.

If I were going to make this trade, I'd wait and see if the price comes down to somewhere near Ichan's price point. It's a good bet his plan works at 25 a share, not so certain it works much higher than that.

Comments: View Comments |  Wednesday May 14, 2008  |  Stocks: YHOO,

Exxon Mobil's (XOM) earnings report last week made them the Rodney Dangerfield of stocks; they got no respect. On 1 May, the company reported quarterly earnings of $10.9 billion or $2.03 per share. The second largest US quarterly profit ever recorded. In case you're wondering who had the biggest quarter, it was also XOM in the 3rd quarter 2007.

Problem was, Wall Street's analysts were looking for even more. The market was also concerned about a 6% drop in production despite spending nearly $5.5 billion on exploration and production. The shares sold off a little more that $3.30 per share or 3.6%. No respect from investors.

Then the politicians got in the picture. This AP piece has a statement from New York Sen. Charles Schumer, "Oil companies are racking up obscene profits left and right while American families are stretched to the limit by skyrocketing gas prices, it's time for Big Oil to pay its fair share." No respect from the politicians.

By now you've all heard the proposals for windfall profit taxes, never mind that the authors can't define a windfall profit. You've also heard the company's defenders stating that big oil's profit margins are not out of line with other industries and pointing out the billions XOM pays in taxes. For those keeping score, retail gasoline prices have risen from $1.51 per gallon when President Bush took office to $3.66 per gallon today. That amounts to an average increase of about 13% per year. If you'd rather blame the other folks, prices have gone from $2.28 per gallon to $3.66, an annualized increase of nearly 44%, since Ms. Pelosi and Mr. Reid promised us lower gas prices when they took over leadership of Congress. Gas price source. Clearly neither party's politicians have been able to do anything to rein in rising oil and gasoline prices.

Politics may be fun but the key question is, can we make any money with XOM? The stock closed at 89.61 on 6 May, up 12.8% over the past 12 months. I was surprised that return wasn't higher. The stock trades at a fwd PE of 10.55; competitors Chevron (CVX) and Conoco Philips (COP) have fwd PE's of 9.43 and 8.07 respectively. XOM just raised their dividend to 0.40 cents per share for a yield of 1.8%.

The biggest business components for XOM and the other integrated oil companies are the upstream, exploration and production business, and downstream, refining and marketing business. $8.8 billion of XOM's profits came from the upstream, leaving the refining side of the business barely breaking even - if you can call a little over $1 billion in profit 'breaking even.' Chevron's earnings report was the same story, big profits from the upstream business and next to nothing from the downstream.

There doesn't seem to be any end in sight to oil demand and high crude prices, so it makes sense to have some investment in the sector. Even with US consumption scaling back, China, India, et. al. are more than picking up the slack. A big integrated oil company gets you exposure to a wide range of energy businesses. For more aggressive investors, companies specializing in exploration and production are likely to perform better than a broad based integrated oil company in the near term. Refiners are having a tough time making money. With the big guys having trouble expanding production, oil service firms and drillers should continue to do well and smaller companies with reserves will be potential buy-out targets. I have a preference for strong dividend players, so prefer CVX to XOM. I also think COP offers a little better value than XOM. There are also a number of foreign competitors that trade in New York; PBR, TOT, BP, RDS, and others that are worth a look. Bottom line, XOM isn't my favorite choice in the oil industry, but I believe it's likely to continue outperforming the market for the foreseeable future.

Disclosure: At time of writing, I'm a happy CVX shareholder.

Comments: View Comments |  Wednesday May 7, 2008  |  Stocks: cop, cvx, xom,

I'm revisiting a losing investment from last year, NN Inc. (NNBR). I had picked this as an outperform in Motley Fool CAPS. Shortly after picking it, they ran into real problems getting production on line at a new plant in China and a recent acquisition, Whirlaway, wasn't performing well. I also bought a little of the stock. Long story short - lost both money and CAPS points. If you're interested in that saga, you can find it by expanding the pitch for the 6/12/07 pick on the closed picks tab of my CAPS page.

NNBR is a small $175 M market cap company that makes bearing components and precision metal and plastic parts. They pay a dividend with a yield of 3.0% based on Friday's closing price. Yahoo's stats page shows $114M of debt and $13M cash, and a price-to-book value of 1.2. Those figures are as of 31 Dec 07. During the conference call they stated debt was $111 million at the end of March and they plan on paying down about $20 million of debt over the rest of the year.

An interesting thing happened last week. NNBR reported actual earnings. When I closed the CAPS pick last year, I thought it was a good investment IF they turned the business around.

Revenues for the quarter ended 31 March were $121.5 million. Annualized, that puts the company selling at about a third of sales. Earnings for the quarter were $5.1 million or 0.32 per share. Annualizing that rate gives a PE of 8.6.

According to the conference call, about 70% of the revenues come from outside the US and their customers have strong business forecasts. Also key, they are able to pass higher material costs along to their customers.

NNBR is still seeing weakness in their plastics division, which sells to the automotive industry. But that's in their forecasts. Key quote from the earnings release - Roderick R. Baty, Chairman and Chief Executive Officer commented, "In the latter part of 2007, we began to see evidence of improvements in three operations - Whirlaway, Slovakia and China. During the first quarter of 2008, we experienced improved profitability and operating margins at each of these locations as compared to the prior year, due mainly to higher capacity utilization resulting from new business awards at all three operations."

If they've turned the poor performing business segments around, the stock could easily double over the next year. If the last quarter was just a blip and they return to poor performance, my CAPS score will suffer again and my sloport will take a hit.

I entered a limit order at Marketocracy, but between a low limit price and very thin volume, only 100 shares have filled so far. I haven't been brave enough to buy any again in real life yet.

Other notes:
I'll be reducing my position in Graham (GHM). It's a great company and has had a fantastic run. But, the price is approaching my fair value estimate and, as much as I want to ride it higher, discipline dictates taking some profits. I will keep some shares in the game to see if the run continues. Will be doing the same in my real account.

AT&T closed over 40 on Friday. Maybe someone is finally realizing a 4% yield from T is a much better deal than 3% on a treasury.

You can make money swimming upstream. Over the course of SLO, I've made a whole 28 dollars on WFC along with a couple $k of dividends. Who'd of thought you could make money long a bank over the last nine months? Kind of like beating your head against the wall.

Also raised a little cash on Friday by reducing positions in BUD and CAG. Still waiting to see if SYY will come back down to buy in. If SYY keeps running, I'll re-evaluate the plan to swap out of CAG.

Disclosure: At time of posting, I own shares of GHM, T, BUD and WFC.

Recommend checking Marketocracy's dividend credits to your accounts. Three of my last four have been incorrect; they've either used the wrong number of shares or had the wrong dividend rate.

Jamie, can we get an update to the leaderboard?
ETA - Ask and receive! Thanks.

Thanks for reading and have a great week.

Comments: View Comments |  Saturday May 3, 2008  |  Stocks: nnbr,