The stock market has entered a bear market this year due to 40-year high inflation and fears of an upcoming recession. Given the prevailing uncertainty and the material downside risk, it is only natural that investors are looking for safe havens. Oil refiners have provided a safe haven to their shareholders so far, as they have outperformed the S&P 500 by an impressive margin. To be sure, while the S&P 500 has declined 16% this year, Valero Energy (VLO), Marathon Petroleum (MPC) and HF Sinclair (DINO) have rallied 60%, 60% and 63%, respectively.

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The vast outperformance of refiners has resulted primarily from the sanctions of western countries on Russia for its invasion in Ukraine. Russia produces 10% of global oil output and an even greater share of global production of refined products. Consequently, the sanctions have tightened the global market of refined products, such as diesel and gasoline, to the extreme and hence refining margins have skyrocketed to record levels this year.

Thanks to this development, all the major U.S. refiners have posted record earnings per share in the first half of the year. As the sanctions are not likely to be withdrawn in the near future, these companies are on track to post record earnings this year. In this article, we will analyze the prospects of three major refiners, namely Valero, Marathon Petroleum and HF Sinclair.

Valero

Valero is the largest independent petroleum refiner in the world. It owns 15 refineries in the U.S., Canada and the U.K. and has a total capacity of about 3.2 million barrels per day. It also produces renewable diesel and has a midstream segment, Valero Energy Partners LP, but its contribution to total earnings is under 10%. As a result, Valero should be viewed as a nearly pure refiner.

Valero has refineries with high complexity and thus it is the most flexible U.S. refiner with respect to the blend of crude oil grades it processes and the product mix it generates. This is a significant competitive advantage, especially during downturns, when the least flexible refineries are forced to shut down and the most complex ones keep making a profit.

Just like all the other refiners, Valero enjoys great business momentum this year thanks to the all-time high refining margins, which have resulted from the sanctions of the U.S. and Europe on Russia. In the second quarter, Valero posted blowout earnings per share of $11.36 and thus exceeded the analysts’ estimates by an impressive $2.16. It is remarkable that the earnings per share of Valero in a single quarter were much higher than its record annual earnings per share of $7.99, which were achieved in 2015.

Moreover, refining margins have remained at record levels thanks to strong demand for oil products, the permanent shutdown of some refineries around the globe in the last two years due to the pandemic and tight supply due to the Ukrainian crisis. Given all these tailwinds, Valero is on track to grow its earnings per share from $2.81 in 2021 to approximately $23.00 this year.

Valero is currently offering a dividend yield of 2.4%. As the company has a payout ratio of only 17% and a solid balance sheet, its dividend is safe for the foreseeable future. On the other hand, as the stock has enjoyed a breathtaking rally this year, its dividend yield has fallen to an 8-year low level. Given also the high cyclicality of refining margins, investors should probably wait for a more attractive entry point.

Marathon Petroleum

Marathon Petroleum was spun off from Marathon Oil Corporation (MRO) in 2011. After the acquisition of Andeavor Logistics in October of 2018, Marathon has nearly reached the capacity of Valero, with 16 refineries and a refining capacity of 3.1 million barrels per day. It also has a marketing system that includes ~7,100 branded locations.

The acquisition of Andeavor has greatly enhanced the geographic diversification of Marathon and its potential to take advantage of fluctuations in price spreads among different types of crude oil and the dynamics of export markets. However, the company remains highly sensitive to the cycles of refining margins.

On the other hand, Marathon is thriving right now. Thanks to the recovery of the global demand for refined products from the pandemic and the extremely tight supply caused by the aforementioned sanctions of western countries on Russia, Marathon saw its refining margins more than triple in the second quarter over last year’s quarter, from $12.45 to $37.54, an all-time high level. Marathon also enhanced its refinery utilization from 94% to 100% and thus its refining segment grew its EBITDA from $0.7 billion to a record $7.7 billion. As a result, its earnings per share jumped from $0.67 to an all-time high of $10.61. Given the blowout refining margins, which have remained in place in the running quarter due to the war in Ukraine, the company is on track to achieve record earnings per share of about $20.00 this year.

Marathon is currently offering a dividend yield of 2.2%. As it has a payout ratio of only 12%, its dividend should be considered safe. On the other hand, just like Valero, Marathon is currently offering an 8-year low dividend yield due to its relentless rally. Therefore, investors should probably wait for a more opportune entry point.

HF Sinclair

In March 2022, HollyFrontier (HFC) changed its name to HF Sinclair (DINO) to reflect its acquisition of Sinclair Oil. The latter has two refineries based at Rocky Mountain, a renewable diesel business and a branded marketing business. Nevertheless, HF Sinclair should be viewed primarily as a refiner.

In late 2021, HF Sinclair acquired the Puget Sound Refinery from Shell for $350 million. The company funded the acquisition with cash on hand and the suspension of its dividend for one year. The timing of the acquisition proved perfect, as the acquired refinery is generating excessive profits this year. In addition, management should be praised for sacrificing the dividend for one year in favor of long-term growth. That was a rare strategic move, as most managements avoid suspending dividends in favor of growth projects.

HF Sinclair enjoys ideal business conditions this year. In the second quarter, its refining margin more than tripled over the prior year’s quarter, from $11.7 to $36.4 per barrel, and its refinery throughput grew 51%, mostly thanks to the acquisition of the Puget Sound Refinery. As a result, its earnings per share jumped from $0.87 to an all-time high of $5.59, thus exceeding the analysts’ estimates by $1.04. Given the sustained rally of refining margins, HF Sinclair is poised to achieve record earnings per share of about $12.80 this year.

HF Sinclair has reinstated its dividend and is now offering a 2.9% dividend yield. The stock has a payout ratio of only 13% and hence its dividend is entirely safe. It is also worth noting that its dividend yield is significantly higher than the yields of Valero and Marathon. Given also that HF Sinclair has the strongest balance sheet in its peer group, the stock seems more attractive than its peers.

Final Thoughts

All the U.S. refiners are thriving this year thanks to the unprecedented refining margins, which have resulted from the Ukrainian crisis. Thanks to the ideal business landscape, the above three refiners are offering safe dividends and are strengthening their balance sheets at a fast clip. On the other hand, investors should always keep in mind the dramatic cycles of refining margins. Whenever the sanctions of western countries on Russia loosen, refining margins will deflate. Even if these sanctions remain in place for years, most countries will do their best to reduce their dependence on oil. In fact, they are already investing in renewable energy projects at a record pace. These efforts will take their toll on refining margins in a few years. Overall, refiners are likely to continue thriving for the foreseeable future but investors should never forget the cyclical nature of the refining industry.

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