PBF Energy (PBF) is a bargain at current market prices. PBF’s adept management team, in conjunction with private equity partners, acquired its core refining assets at fire sale prices in 2010 and 2011. Among these assets are the Paulsboro and Delaware City refineries which, following initial turnarounds, are now the crown-jewels of the East Coast (PADD 1) refining system. East Coast refineries have historically lacked the structural advantages of their Mid-Continent and Gulf-Coast counterparts. However, management’s aggressive investment program in a “crude-by-rail” logistical infrastructure promises to close the gap by adding much lacking optionality through access to cost advantaged crudes. Although the ownership structure has legacy problems and the company will undoubtedly continue to face cyclical margin and secular regulatory issues, the stock is much too cheap. A discounted cash flow analysis and an economic book value analysis convergingly indicate that the stock is fairly valued at around $50 per share (about 60% higher than current prices of about $31/share). Continue reading →
Valero Energy Corporation’s (VLO) conservative valuation reflects a history of and expectations for cyclical margin pressures, secular regulatory pressures, and a management regime which does not create excess long-term shareholder value.
Management has singled out asset drop-downs to company sponsored MLP, Valero Energy Partners (VLP), as the most promising avenue for unlocking shareholder value.
Although the value gap between VLO and VLP is real, unless management radically accelerates VLP’s financing trajectory, the drop-down strategy will not significantly drive excess returns for VLO shareholders.
Disproportionate focus on arbitraging market value dislocations could detract from more enduring drivers of long-term value such as distressed asset acquisitions and continuous rationalization of core refining and logistics assets.
VLO’s core refining assets are among the best positioned and most complex in the world. If competently utilized, these assets are worth significantly more than the company’s market capitalization.
Refiners make money by cracking crude oil throughputs into valued-added products (i.e., yields). Crack spreads are cyclical and volatile.
Refiners have adapted to margin volatility by engaging in derivatives contracts which off-set short and medium commodity price risks and by investing in assets which are able to process cost-advantaged crudes and optimize yields of higher value products.
Vertically integrated refiners are further able insulate themselves from commodity risks and exert more pricing power.
Ceteris parabus, long-term crack spreads will be upheld simply due to the fact that markets tend to value refining assets at or below their replacement costs (RCN).
Compliance and regulatory measures are a more serious threat to the long-term viability of domestic refiners since they often elicit unintended economic consequences.
In the world of investing and corporate finance, the Efficient Market Hypothesis (EMH) casts a long shadow. EMH states that a sufficiently liquid market reflects the “correct” price at all times. Since efficient markets factor in all known and relevant information at all times, it is therefore practically futile to attempt to predict the future direction of market prices. In other words, a blindfolded monkey throwing darts at the Wall Street Journal has about the same chance as beating the market averages as any professional investor. At one extreme, the founder of Vanguard Investments Jack Bogle revolutionized the mutual fund industry around cheap indexing, which he posited as the solution to efficient markets. At the other, Warren Buffet’s seminal essay, The Super-Investors of Graham and Doddes-ville, defends the notion that right-headed investors can carve out a significant edge 1. In the middle, you have the greater majority of investors who will likely cede that both extremes contain some amount of the truth. Even 2013 Nobel Laureate Eugene Fama, of the University of Chicago Booth School of Business, who is credited with developing EMH, has stated that “[asset prices] are typically right and wrong about half the time” 2. Being able to determine when they are right and when they are wrong is the holy grail to traders and investors alike. In order to investigate how correctly assets prices reflect all known information, we must develop an intuition and methodology for estimating the fair value of an asset. As we will discuss, just because a methodology is descriptive does not mean it is predictive (i.e., correlation does not imply causation). Continue reading →