Hollyfrontier (HFC)

refine

Key Statistics

Enterprise Value = $10.752 billion

Operating Income = $1.642 billion

EV/Operating Income = 6.54x

Price/Revenue = .51x

Earnings Yield = 12%

Debt/Equity = 41%

The Company

Hollyfrontier is a U.S. oil refiner. They refine oil into gasoline, diesel fuel, jet fuel, asphalt, lubricants, etc. They operate 5 refineries and process 457,000 barrels of oil a day. They are headquartered in Dallas, have been operating since 1947, and operate mostly in U.S. red states.

My Take

Hollyfrontier has done extraordinarily well over the last three years. The refining business has been good and the stock is up over 125% from its lows reached in 2016. The current cheapness is mostly a result of how well the business has performed and recent price declines. The stock is down 35% from its high in June 2018. A bulk of this downturn happened late last year, when markets paniced because everyone thought the Fed was going to push the economy into a recession and, also, because everyone is crazy and overreacts.

The biggest risk to Hollyfrontier is dramatic fluctuations in price of oil. Hollyfrontier makes money through the price spread between refined products and the oil itself. Those prices are largely unpredictable. Hollyfrontier can’t control what happens to prices. This uncertainty with oil prices is a key cause of the cheap valuation. When Hollyfrontier encounters good times, for instance, the market doesn’t have any confidence that the good times will last.

Another significant risk to Hollyfrontier is the risk of a recession, which will hurt demand for refined products. As I’ve stated many times before on this blog, I don’t think we are having a recession in the next year. Of course, the caveat here is that’s just like my opinion, man.

Hollyfrontier focuses on factors that they can control, not the price of oil. To control price fluctuations in their raw materials, they purchase derivative contracts to protect themselves against adverse price fluctuations. They are also focused on expanding their footprint and continuing to grow the business through expansion and strategic purchases of other businesses.

Hollyfrontier’s July 2018 purchase of Red Giant Oil in July is a good example of their acquisition strategy. Red Giant Oil was a small family-owned business. Red Giant produces an EBITDA of about $7.5 million. Hollyfrontier paid a reasonable price: $54.2 million, or a multiple of 7.23x. This demonstrates that while management is committed to expansion, it is not in the style of shareholder value destroying “empire building” expansion. They are pursuing acquisitions that help them strategically and are doing so at reasonable prices.

Over time, Hollyfrontier will continue to grow through acquisitions and organic growth of the business. Demand for refined products is never going away and even though the prices are volatile, over the long run Hollyfrontier should do well and continue to grow earnings and cash flow.

From a relative valuation standpoint, Hollyfrontier’s P/E is currently at 8.42 compares to an industry average of 12.87. On a price/sales basis, the current .51x multiple compares to an industry average of 1.8x. A rise to the average levels for the industry would be a significant price increase from the current multiple.

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