Investors who have been living under a shale rock formation in the last five years may have failed to notice the revolutionary energy transformation under way in the U.S., where natural gas and oil production are up 33% and 46% in the last five years. But as avid followers of B400 may have guessed, our index has indeed participated in the revolution and benefitted handsomely. It has done so through the selection of myriad energy companies from exploration and production companies to refiners, pipeline operators and service providers. Today’s column will highlight one of B400’s most successful picks in the space, which happens to be on sale right now.
Sugarland, Texas-based CVR Energy, Inc. (CVI) has been a member of B400 since September 2011, when it was trading at $26.56 a share, the price at which the stock officially entered B400. Based on last night’s close of $45.78, this represents a tidy 72.4% gain in a little less than two years. While we’ll take the gain, it represents only a fraction of the 165% paper gain B400 had not long ago when the stock reached an all-time high of $70.38 on May 28th. What happened since then that has ‘Mr. Market,’ to once again borrow from Ben Graham, offering the stock for two thirds of its value of less than two months ago? The story goes as follows.
The stock started falling in late May, along with the broader market, on expectations that the Fed would soon begin to slow the pace of its asset purchases. During this mini correction Energy shares were particularly hard hit, as represented by a 7.5% decline in the widely followed Energy Select Sector SPDR ETF (XLE), from peak to trough on June 24th. This contrasts with the 5.7% decline in the Dow Jones U.S. Total Stock Market Index during the same period. But contrary to the market recovery that ensued, CVI continued to fall, with the sell-off in its shares picking up steam after Goldman Sachs downgraded the stock from Neutral to Sell on June 10th on the view that shares appeared fully valued. Goldman also issued a 12-month price target of $56 for CVI. We think the sell-off has been overdone, giving investors an opportunity to buy a remarkable company at a bargain valuation. But before we get into the fundamentals, a bit of the qualitative story for perspective and context.
Some of you may have recently noticed the rapidly shrinking gap between the price of a barrel of oil as tracked by the two widely followed benchmarks, WTI and Brent, which we have illustrated in the chart below. Why has this happened and why was there a dichotomy in the first place? WTI (West Texas Intermediate) benchmarks sweet light crude oil that has been mostly stranded in the massive storage hub of Cushing, Oklahoma, in large part as a result of a shortage in pipelines to carry it to the Texas Gulf Coast, where a quarter of U.S. crude is refined. Not to mention the fact that U.S. law forbids the export of most crude (but not of refined products) since the 1970s oil embargo. WTI price, thus, has been historically limited to producers’ ability to move their crude to refineries that can process it for export as petroleum byproducts or for domestic gasoline consumption. Brent, on the other hand, benchmarks imported European oil, of a heavier kind than WTI, which moves more freely around the world, even if much of it isn’t indeed ‘European.’ Its free movement and widespread availability has in large part been responsible for its price premium.
As the U.S. has seen its oil output rise to the highest level in 17 years thanks to the shale fracking revolution, with a large chunk of it coming from Texas and Oklahoma producers, a massive glut of crude stuck in Cushing has benefitted refiners located in the middle of the country, which is exactly where CVR Energy happens to have its two refineries, in Coffeyville, Kansas and Wynnewood, Oklahoma. Such refiners have had an advantage over Gulf Coast refiners, not to mention East and West coast refiners, who have to add the cost of transporting the oil by rail to the price of crude itself. Advantage CVR Energy, who’s had access to plentiful nearby crude at WTI prices, which it refines into petroleum derivatives in one of its plants and into nitrogen fertilizer in the other; it then sells the refined products at national prices and earns higher margins than its competitors disadvantaged by location. But part of that advantage is about to shrink, which helps explain the sudden swoon in the price of the stock. The primary reason being that no less than seven pipelines carrying crude from Cushing to the Gulf Coast will be in operation by the end of 2014 following a massive build out by other energy outfits wanting in on the WTI action. This has helped in large part close the gap in prices between WTI and Brent. While we won’t argue that part of CVI’s margin advantage will disappear with a rising price of WTI and greater competition for domestic shale oil, we think this view is myopic and misguided at these prices. What sellers of the stock have failed to recognize, we think, is that rather than fight for a slice of a finite energy pie, U.S. producers and refiners will more likely share in the benefits of a significantly higher pie as the U.S. becomes a net exporter of energy over the course of this decade, politicians’ posturing aside. Which finally brings us back to CVI.
It should be noted that 82% of the company’s outstanding shares are owned by Carl Icahn’s hedge fund, representing its largest holding. We view this as a positive. Also, investors should also understand that CVI’s assets are actually housed in two separate Master Limited Partnerships, in which it acts as the general partner. The company owns 71% of CVR Refining LP (CVRR), which focuses on the production of petroleum products and 53% of CVR Partners LP, which focuses on the production of nitrogen fertilizer.
After the recent sell-off the company sports a market cap of $3.9 billion, B400’s sweet spot and its shares are yielding 6.6%. The stock trades at seven times trailing 12-month earnings per share and 9.9 times forward EPS estimates. Price to book is 3.1. The company generated $638 million of free cash flow during the 12 months ended in March, compared to $43 million three years ago. Equally impressive, current shareholders’ equity stands at $1.9 billion compared to $656 million also three years ago. Such rare combination of growth and value makes it one of those rare companies in MarketGrader that have equally high marks in both those areas of our analysis. Our overall grade for CVI is a remarkable 88.1, while grading the company from its Growth or its Value profile yields identical overall grades of 87.8. Call it GAAP (Growth At an Amazing Price).
CVR Energy has, technically, $677 million in debt, which is canceled out by its $1 billion of cash on hand. 12-month trailing return on equity is a whopping 40%. And yes, the stock is trading one third below its 52-week high. Says B400: me like! Don’t be surprised if its B400 tenure is thus extended after the upcoming September selection.
