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The Best in Independent Refining

Credit Suisse says Marathon Petroleum is its top pick.

Credit Suisse

Today we formalize the cuts to earnings per share flagged in our Seaway What-If Scenario report from last week.

In that note we suggested a 40% cut to 2012 EPS was required on average.

Our actual cut is 42% (we’ve also incorporated slightly weaker West Coast benchmark margins, and narrower Maya [Mexican] and Light Louisiana Sweet crude spreads).

Our 2012 estimates are 30% below consensus. We cut target prices by about 15%. With EPS in free fall one year earlier than expected and macro uncertainty in Europe remaining center stage, share-price appreciation could take some time, even if value remains. As management teams watch next year’s profits shrink, we believe there is still more than enough free cash flow to support a decent yield — they should act sooner rather than later. When confidence returns, the complexity and crude advantages of U.S. refiners are still meaningful. There is longer-term upside. We reiterate Marathon Petroleum (ticker: MPC) as our top refining pick.

Generally, we have taken care to model as closely as possible the actual refinery location in order to appropriately capture crude cost locations that a generic West Texas Intermediate (WTI)-linked marker will not reflect. We now assume a WTI-LLS spread of $6.75 per barrel in 2012 and $3 per barrel longer term.

HollyFrontier (HFC) should benefit in its Woods Cross and Cheyenne refineries from local crude discounts (e.g., Niobrara and Bakken). HollyFrontier will also be able to capture increased black wax spreads as the Uinta grows.

Tesoro (TSO) should also benefit from local crudes into Mandan and Salt Lake City.

Western Refining (WNR) is targeting an improved gathering advantage from local Permian shales. Cash flows are also supported by the company’s hedging program.

CVR Energy (CVR) and Delek US Holdings (DK) have limited offsets in our model to the change in cracks. We suspect that capture rates of lower margins should improve as low-valued products not reflected in a benchmark 3-2-1 [crude-gasoline-distillate profit margin or crack spread] or 2-1-1 will be a lower percentage of a lowered crack.

For Marathon and Valero Energy (VLO) we have pushed back the timing of Gulf Coast refineries being swamped by onshore crude supply by one year to 2015. This results in lowered 2014 EPS. The Mid-Continent specific cuts to earnings are more muted.

Even after these EPS cuts, free-cash generation remains strong. We remain above consensus for Marathon and Valero in 2013.

Although more pipes need to be built (either Seaway expansion, Wrangler or Keystone XL) to bring Canadian crudes into the U.S. and to solve domestic U.S. bottlenecks, the Seaway announcement will likely shift investors to a pipeline-linked world. What does this look like? Inside we lay out our view, complex inland refiners will still have advantaged input costs and sell their products at premium prices. They will generate good free cashflow for their equity holders and some refineries, e.g., Mandan, Salt Lake City, and Billings, will earn even higher returns. Complex Gulf Coast refiners should also generate a return driven by cheap heavy crude feedstocks and high distillate margins. Valero has only failed to meet its cost of capital twice in the last decade.

There are quite a few nuances: 1) Enterprise Products Partners (EPD)- Enbridge (ENB) hold the cards in terms of setting the tariff absent any competition. The tariff could be higher than our $3-per-barrel WTI-LLS longer-term assumption, which we think should generate a healthy 14% unlevered internal rate of return for Enbridge; 2) more than one pipeline will be required to resolve longer-term supply growth. Hence, there will continue to be the potential for spikes; 3) we don’t assume a blanket WTI feedstock cost across the U.S. refining group’s earnings. Some crudes, e.g., Bakken, Uinta, Niobrara and early Utica, that cannot get to Cushing via pipeline will still trade at a $10-$12-per-barrel discount versus LLS; that is a $7-$9-per-barrel discount to WTI-based on rail-logistic costs. This represents an advantage for some of HollyFrontier’s and Tesoro’s refineries. Conversely, Marathon needs to bid WTI up to bring barrels up from Patoka until the Utica kicks in (we recently heard the Utica oil window could be pressured); 4) Permian producers are more likely to get the full benefit of Seaway in their realizations, although a narrower WTI-LLS spread should benefit all explorers and producers.

– Edward Westlake
– Rakesh Advani

Read More: http://online.barrons.com/article/SB50001424052748704677404577044590697448270.html?mod=BOL_da_is

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Published on: November 18, 2011

Filled Under: Companies

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