Another day, another triple-digit drop for the Dow. Breaking it down by sector, many of today’s biggest losers are energy stocks:
- Halliburton Co. (HAL), down 5%
- Transocean Ltd. (RIG), down 4%
- Marathon Oil Corp. (MRO), down 4%
- Hess Corp. (HES), down 4%
- Valero Energy Corp. (VLO), down 4%
- Anadarko Petroleum Corp. (APC), down 3%
As a whole, this sector is off over 2.5% today, and it makes sense that these stocks are falling harder than others. The net effect of the U.S. dollar suddenly getting its “mojo” back is that commodity prices are now falling fast. That’s because commodities like crude oil are priced in U.S. dollars. So in March, wholesale energy prices retreated 3.4%—the largest such decline in three years. At the consumer level, gas prices fell 4.4%.
And now that prices have retreated even further on news of slower growth in China, some economists are wondering how far they have left to fall. Does this mean that we want to avoid energy bets wholesale?
Not by a long shot.
The Silver Lining To Black Gold
The silver lining to this pullback is that it should give you a chance to pick up some premium energy stocks on the cheap. That’s not to say that I want you to start loading up on all energy companies—the drop in energy prices poses challenges for some companies. However, there is a class of energy companies that deserves a closer look: Midwest refiners.
Refinery stocks have been volatile recently due to concerns over margins, necessary maintenance ahead of the summer driving season and rising costs for renewable fuel credits. Valero Energy (VLO) recently stated that it expects to have to pay $300 million to $400 million to comply with cleaner-gasoline requirements. This caused a lot of investor anxiety about refiners across the board.
The U.S. government requires that refiners blend a certain amount of ethanol—or other biofuels—into its gasoline. If a company can’t meet requirements, they need to purchase renewable-fuel credits (RIN) to cover the shortfall. Because RIN costs are rising, some analysts have said that “RINflation” could weigh on profit margins. But I’m not buying into these concerns. It will take some time for rising RIN costs to impact profits; many refiners have stockpiled RIN credits to last through the end of next year.
This issue is causing investors to not see the forest for the trees—despite the regulatory drama, there’s good long-term profit potential supporting these stocks. As I mentioned, fuel prices at the pump are falling. However, they’re not falling as fast as crude oil prices, which has been in free fall thanks to the glut of sweet crude oil piling up in North America. Many Midwest refiners are able to buy the crude oil on the cheap, and turn around and sell their refined product for a profit.
So contrary to the bad press that’s been circulating, most refiners are doing just fine. In fact, analysts expect that the average refiner will post 6% earnings growth this quarter, 8% growth next quarter, and 6% for the year. Next year, that estimate more than doubles to 13% bottom-line growth. While this may not sound like blowout growth, there are certain refiners that I’ve had my eye on for their profit potential.
Profit Action: Buy CVR Energy Inc.
One is CVR Energy Inc. (CVI), whose roots extend back more than a hundred years. In addition to perfecting clean transportation fuel, the company has also expanded its operations to produce nitrogen fertilizer products. What’s neat about the two operations is that CVR takes the petroleum coke produced by its refinery and uses it to make its nitrogen fertilizer. CVR is the only producer in North America that uses this process. And, CVR is no lightweight: Between the two divisions, CVR brought in over $8 billion in sales last year.
This company is slated to announce earnings on Monday, May 6, and its prospects are stunning. Currently, the Street expects the company to grow sales by nearly 12% and earnings by 109%. But considering that the company has managed to post double-digit earnings surprises several quarters running, we could very well see even stronger performance from CVR Energy. Click here to see my full Report Card page for CVI.
P.S. If you’re interested in other premium refiners and pipeline plays, I currently have several in my Emerging Growth newsletter. You can read more about how American energy independence is making my Emerging Growth readers rich here.