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Are These High Beta Oil Refiners Ready for Correction?

Saturday - 4/6/2013, 5:43pm  ET

The latest standard issued by the U.S. Environmental Protection Agency regarding sulfur content in gasoline has set a cat among the pigeons, and could potentially lead to bearish overtures for oil refining and marketing companies such as CVR Energy , Delek , and Alon .

The regulator plans to reduce the content from today’s standard of 30 parts per million (ppm) to 10 ppm by 2017. This is not entirely a new development for oil companies as the rules have been in the making for more than a year, but this is the first time the EPA made a formal proposal.

If the proposal becomes a rule, oil refiners will need to spend tens of million dollars to fit their refineries with costly equipment. The American Petroleum Institute (API) says the new rule would drive up gasoline prices by up to 9 cents per gallon, directly affecting demand, and by extension, consumption of fuel.

Needless to say, it is being viewed as a step which can potentially curtail the rally in refining stocks. The threat is particularly strong in case of overbought and high beta stocks.

CVR Energy currently trades at around $49 after dropping nearly 15% over the last month. This high beta stock recently created a new 52-week high in early March, but has been on a slide since then as concerns that increasing renewable fuel credits would pressurize refining margins. However, the refiner has now one more headwind to battle in the form of potentially higher retrofit costs.

The company's financial performance in the most recent quarter has been dismal, as revenue growth did not translate into higher profits. While technical indicators suggest the stock is oversold, it may be a while before buying emerges back. The stock continues to trade below its 50-day and 200-day moving averages, an indication that bears are still strong in the stock.

High beta not good during slide

Similarly, Tennessee-based Delek is an integrated player in the space and operates in petroleum refining, wholesale distribution of refined products, and convenience store retailing. The stock has moved up 161% over the past year even after taking into account nearly a 6% correction recently.

While the company has reported vastly improved financials in recent quarters, its price to book value ratio of 2.5 may be indicative of the fact that shares have rallied beyond fundamentals. It is also worth noting that the company’s margin on retailing operations -- its second largest segment -- is already under pressure, and prospects of a squeeze on refining margins would only contribute to the sell off.

Due to its high beta nature, the stock tends to move along with the wider market, but at a greater scale. As a result, Delek can be expected to drop to a large extent if the stock market comes under bear grip.

Debt concerns

Alon has lost nearly 14.3% in the last several weeks, but there appears to be more downside in absence of support at lower levels. After having moved up 96% over the last 12 months and 32% over the last six months, investors may be wary of buying the stock at slightly lower levels, which may be contributing to the recent weakness.

The trading sentiment seems to have turned negative on the stock, which explains why it failed to move up despite reporting a profitable December quarter – a substantial improvement from the same quarter in 2011. High debt on its balance sheet is another reason investors may not look favorably at the stock at lower levels. As of Dec. 31, the company’s debt stood at $587 million compared to equity of $621 million.

Although debt has come down from 2011, it is still a concern for investors. With nearly 8% of the shares in the market shorted, the downward pressure on the stock is obvious.

Foolish bottom line

It's true, that the party must come to an end; there has to be an interruption, if not a full stop, to the rally in oil refinery stocks. The EPA’s proposal is capable of dealing a deadly blow to these stocks, and thus, investors would do well to keep an eye on how the regulation pans out.

This article was originally published as Are These High Beta Oil Refiners Ready for Correction?on

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