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A Breakdown in Quant Land? See Also: Buy Refiners |
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With all of the volatility lately, I’ve noticed some odd trading patterns in a number of stocks - and today, Valero (VLO) jumped out at me. While most energy stocks advanced nicely today, VLO was down 1.7% Five ratings initiations by Bank of America certainly added to the movement, but at the end of the day VLO was down and Frontier Oil (FTO) was up over 4% on heavy buying. Additionally, the hurricane (since downgraded to a tropical storm) headed for Texas likely put some additional damper on buying enthusiasm for VLO, but brushing that aside I thought reevaluating refining stocks right now couldn’t hurt. Back in May, I did an analysis of the valuations being placed on refining stocks using a barrel-per-day of refining capacity metric I called EV/BPD. Updating those valuations involves making a few changes to financials (the $2.1 billion deal Valero closed on with Husky), but for Valero I calculate an EV/BPD of $12,932 on $40.1B/3.1mBpD, and for Frontier I arrive at an EV/BPD of $24,691 on $4.0B/160k. What can explain this valuation premium (by this metric) placed on FTO? A big part of it is that Frontier has better margins - 50% higher than Valero’s - and the ROE for Frontier is about twice as high as Valero’s 34%. I’m not very concerned about digging in to the valuation and determining a clear long-term winner here; both Valero and Frontier are extremely profitable companies that are cheap given my beliefs about the direction of the crude market. What does interest me is the historically tight correlation that VLO and FTO have with each other, and how that has broken down in the last few days. Given that Valero and Frontier operate in the same business selling commodity products, one could reasonably assume that the two stocks would generally move in sympathy with each other, which has largely held true in the past. Over the last year, the VLO/FTO ratio has been about 1.837, but in the last three days of trading that ratio has moved from 1.712 to 1.567, or a difference of 17.2% from the recent average ratio. |
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The current VLO/FTO ratio is the lowest it has been since July of 1995. The chart above goes back to July 2006, and you can notice the three prior bottoms in the 1.60 +/- .05 area. I’d be looking for a similar bounce to occur, with the ratio to revert to approximately 1.85, which is both close to the mean for the period as well as the ratio given analyst consensus targets for the two stocks (1.887). While this setup implies a purchase of VLO and a short of FTO in equal dollar amounts, I would be just as comfortable going for VLO as a straight buy. Similarly, I think FTO is a great stock to be in, although I would be a bit more patient before I jumped on a position.
I’d like to balance this trading idea out with some more long-term thinking. There is, however, one thing missing from VLO and FTO that I see in one of my top five stocks to own right now - and that would be insider buying. There is plenty of insider buying going on at American Eagle Outfitters (AEO), however, with Board Chairman Jay Schottenstein buying $20 million more in stock last week. American Eagle is a great brand with many desirable characteristics, and the stock comes at a dirt cheap valuation before one even accounts for the huge cash position and great growth that should come from the two brand extensions the company is rolling out right now. Maybe an AEO/ANF quant comparison should be in the works... |