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Refiners Shine, Growth Rewarded, But Value Lags

 December 11, 2012 02:03 PM

(By Mani) Most oil and gas stocks are trading below the mid-point of their five-year ranges on P/E and P/CF, based on 2013 consensus estimates. Their net debt ratios are below historical levels, and their dividend yields are higher.

Among the oil and gas companies, shares of Valero Energy Corp. (NYSE: VLO) trades at the lowest P/E of 6.8 times, with Apache Corp. (NYSE: APA) screens the lowest P/CF of 2.9 times.

However, capital spending levels are up on an absolute basis and as a percentage of operating cash flow as strong industry demand for services pressures costs while return on average capital employed lagged.

[Related -Why Growth Is Deep In The Heart Of Texas]

The WTI crude oil price declined 12.7 percent this year while the natural gas price gained 22.6 percent. Despite this diversion, at current prices of $86.70/barrel and $3.45/ million cubic feet (mcf), respectively, the US natural gas price is 76 percent below WTI crude oil on a 6:1 energy equivalent basis.

"The decline in the oil price and the low gas price negatively impacted the stock performance of the majority of oil and gas producers," Oppenheimer analyst Fadel Gheit wrote in a note to clients.

Stocks of the US-based refiners had a record year with gains of more than 70 percent, mainly driven by the record WTI-Brent crude differential, cheap natural gas, growing refined product exports and declining capital spending.

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Among the refiners, Marathon Petroleum Corp. (NYSE: MPC) have surged 86 percent year-to-date followed by HollyFrontier Corp. (NYSE: HFC) which gained 74 percent.

"Most R&M companies have accelerated returning free cash flow to shareholders through increased regular dividends, special dividends, and share buybacks. We think this trend will continue into 2013 as these structural changes will continue to benefit R&M stocks," Gheit said.

Barring supply disruptions in the Middle East, oil prices are expected to decline next year on weaker than expected global demand and stronger production growth in North America, Russia, and Africa.

"We expect natural gas prices to trend higher, but to encounter resistance above $4/mcf because of the industry's short response time to rising prices, which would boost supply," Gheit noted.

Excluding the refiners, oil and gas stocks have significantly lagged the S&P 500 this year, despite elevated oil prices and the strong recovery in natural gas prices from their April lows. The under-performance was driven by an expected pullback in oil prices and continued weakness in natural gas prices. The only exceptions were the high-production growth companies, which outperformed the S&P 500.

At the same time, refining stocks have benefited from structural changes of wide crude differentials, cheap natural gas, growing product exports and declining CAPEX, which have boosted free cash flow and allowed companies to accelerate returning cash to shareholders through regular and special dividends and share buybacks.

"Although a repeat of this year's record share price gains is unlikely, we think valuation remains attractive and the upside potential remains high," the analyst wrote.

Meanwhile, too many small companies with limited human and financial resources are crowding most unconventional oil and gas plays, paving the way for industry consolidation.

"We think takeover premiums are likely to be low, especially for smaller companies," Gheit noted.

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