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Refiners: A nice place to visit, but I wouldn't want to live there / Strange name, great company / Consequences of a stronger dollar



August 13, 2008 – Comments (5) | RELATED TICKERS: VLO , MIL.DL , MCD

Refiners: A nice place to visit, but I wouldn't want to live there

As I have said in the past, everyone on Earth already knows that there hasn't been a new refinery built in the United States since 1492.  You know what?  I don't care.  Despite the lack of new U.S. refineries and the recent increase in the "crack spread" (their profit margin) I continue to be very bearish on all publicly traded refiners, long-term.

Yes, as anyone who has been watching my CAPS portfolio knows that I have added a couple refiners, VLO and WNR, as short-term plays as oil continues its temporary slide, but I strongly believe that these companies are going to have problems well beyond the fact that the price of oil will likely eventually head higher and more fuel-efficient vehicles will likely be introduced.

What could be worse that higher input costs and lower demand?  How about increased competition.  Searching for ways to invest the riches that they have accumulated over the past several years, Middle Eastern countries, like Saudi Arabia, are building tons of new refining capacity. More refining capacity that's owned by the world's largest oil producing countries and located right next to giant oil fields is bad news for U.S. refiners.  To me, it almost certainly means that the days of huge crack spreads for U.S. refiners are coming to an end.

A Valero refinery


Strange name, great company

In my ongoing quest to diversify my CAPS portfolio, I added a new company today, KHD Humboldt Wedag International (KHD).  In short, HKD helps companies design and build large industrial plants, mainly cement factories, but it also is involved in the and coal and mining industries. 

It looks like things are going well for KHD. It just reported a solid second quarter and demand for its services appears to be robust. Its Q2 EPS came in at $0.63/share, $0.13 better than the estimate of the one analyst who follows the it and an increase of 71% over Q2 '07.  Also, the company reaffirmed its earnings guidance for the year at $2.05-$2.15, compared with an estimate of $2.12.

Its margins improved nicely during the quarter. According to CEO Jim Busche commented, "Our gross profit margin for the six month period ended June 30, 2008 increased to 19.1 percent compared to 14.8 percent for the same period in 2007 and was 19.6 percent compared to 12.2 percent for the three months periods ended June 30, 2008 and 2007, respectively. There were several factors that contributed to the increase including more efficient project execution on a number of projects, cost savings related to the success of our global procurement initiative and the completion of warranty periods on several projects at better than historical levels resulting in the release of provisions on the expiration of these warranty periods."

It experienced a huge surge in its order backlog this quarter, which rose 98% to $1.3 billion.  Of this $1.3 billion, 41% is from Russia and Eastern Europe, 26% from the Middle East, and 26% is from Asia. This is nice to see because all of these areas should be able to withstand the suspected global slowdown much better than the U.S., Western Europe, and Japan. 


KHD has a solid $100 million in cash on the books that it is keeping in U.S. dollars instead of Euros to protect it from a drop in its home currency.  It will likely use this cash horde to expant by purchasing another company.  With the prices of everything on sale, this is an excellent time to go shopping.

KHD Humboldt Wedag International Ltd. Reports 2008 Second Quarter and Six- Month Results


Consequences of a stronger dollar


Hooray the dollar is stronger, the dollar is stronger!!!!  Wait a second, isn’t that bad news for a number of the large multi-national companies that have been benefiting from a weak dollar.  You bet it is.  If the dollar continues to strengthen, expect the earnings results of a number of companies to suffer.  Bespoke posted a great chart the other day showing which industries derive the highest percentage of their revenue abroad.  So who will get hit the hardest by a rising U.S. dollar? 


The answer is technology.  Tech companies derive more than HALF of their revenue from countries other than the United States.  If you really believe that the dollar rally will continue (I personally don't) stay away from tech companies. 

Here's an example of what might happen if the dollar continues to soar.  Today, Credit Suisse lowered its earnings forecast for McDonald's (MCD) for both 2008 and 2009 stating that a 5% rise in the dollar would likely reduce the company's earnings by as much as $0.05 per share. 

International Revenues and the Dollar


Quick Hits 

- Prime mortgages get hit, dashing recovery prospects
"More borrowers with good credit are defaulting on their home loans, and that's going to make it even harder for the staggering housing market to recover."  According to a recent study, the delinquency rate for prime mortgages (for less than $417,000) rose from 1.38% a year ago to 2.44%.  Anyone who believes that this whole credit crunch / housing meltdown is behind us is fooling themselves. 

U.S. June Consumer Credit Up $14.3 Billion, More Than Forecast 
Consumers are increasingly turning to credit cards to help them pay for necessities.  I suspect that consumers will be unable to pay back much more of this credit card debt than expected and that credit card companies liks Capital One (COF) and Discover (DFS) will continue to suffer, as deliquencies and charge-offs rise.  Note, I am still short these two companies in CAPS, but I covered my real-world short positions in them several weeks ago.

 -  NBC Universal off to fast start with Olympic ratings
"The first two days of the Beijing Olympics drew an average audience of 29.1 million, making it the most highly rated broadcast of the Summer Games held outside the United States since 1976."  I definitely did not purchase my stake in General Emectric for its NBC Universal business, but if that section of the company performs better than expected I'll certainly take it.   


Wall Street Losses Cut Tax Bill, Sap New York Revenue 
Add New York to the list of states that are in financial trouble.

Federal Reserve finds deepening credit crisis

-   Budget deficit soars to $102.8 billion in July
"Deficit is nearly triple that of July 2007."  Yeah, this is really an indication of a country that should have a strong currency.

 Why the buck stops here

The dollar has had a nice run, but a soft economy is likely to cut the rally short.


5 Comments – Post Your Own

#1) On August 13, 2008 at 4:17 PM, GNUBEE (< 20) wrote:

Thank Deej,

Not only is Saudi Arabia getting into more refining, but Petrochemical too (lookout DOW and Dupont). Look at SABIC's increases in polyethylene and polymers in the last few years. I think thier "diversification" could be another sign that thier stocks are dwindling.- See VTEngineer2001 's recent blog. Peak Oil is a Done Deal

I too am riding (in CAPS) the refiners until at least next week. Averaging just under a +5 for about 80 picks.

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#2) On August 13, 2008 at 4:22 PM, GS751 (26.89) wrote:

I think about what is going to happen to refiners over the next 20 years, think in Buffett terms that our preferable holding period is forever.

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#3) On August 13, 2008 at 8:05 PM, DemonDoug (30.97) wrote:

"Deficit is nearly triple that of July 2007."  Yeah, this is really an indication of a country that should have a strong currency.

Btw, if you were to, say, annualize that loss, 102.8B x 12 = 1.2336T.  There's your trillion+ deficit for next year, Mr. Next President.  Have fun!

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#4) On August 13, 2008 at 11:27 PM, dexion10 (27.07) wrote:

nice article Deej. I too wrote about refiners (click her to see my post)  as long-term shorts.

btw - while we haven't had new refineries built we do have many expansions and upgrades in progress right now and a new refinery is scheduled to be built in the Dakota - the first in decades. 

All this is bad for refiners given the fall off in demand... marginal refineries may bog belly up ... which would be great for folks like VLO FTO HOC over the mid-term ... but near term it'll be pain for them all.

Also new foreign capacity will decrease the size of the export market over time. That had been a lifeline for these guys 

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#5) On August 14, 2008 at 10:27 AM, saunafool (< 20) wrote:

I disagree. Refiners in the U.S. will continue to do fine, and they only had big crack spreads from about 2003--2007. I worked in the industry from 1992--2007 and before 2003, we where happy when the 3:2:1 was over $7.

For the foreign competition, it is important to note a few things. First, the U.S. currently imports about 3 million barrels per day, mostly from Europe. Second, growth in product demand is very high in the Middle East, so they will consume much of their own product. Third, there are 57 flavors of gasoline in the U.S. and foreign companies who want to export will have to account for that to a degree (although much of it can be taken care of at blending terminals in the receiving ports).

I'm not enthusiastically bullish about the sector, but these guys are trading for 50% of what it would cost to replace their refineries--classic value play. They are going to be here for a long time, and chances are they will continue to make money.


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