Blog > Oil and Energy > CNBC.com plugs refiners Valero (VLO) and Tesoro (TSO) — our Hot Stock Confidential Pick remains best-kept secret!
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CNBC.com plugs refiners Valero (VLO) and Tesoro (TSO) — our Hot Stock Confidential Pick remains best-kept secret!

Posted July 28, 2008

Despite increasing media coverage of oil refiner stocks such as Valero (VLO) and Tesoro (TSO), our Hot Stock Confidential refiner pick is the industry’s best-kept secret!

by J. Christoph Amberger

Baltimore — (TFN): This I found on CNBC.com today, attached to a recommendation of Valero (VLO) and Tesoro (TSO)  — Stock Picks: Good Time for Oil Refiners: “Tumbling oil prices should send investors toward the people who own and run refineries, according to SmartMoney senior markets editor Russell Pearlman.

“‘These guys got slaughtered recently, because they hadn’t been able to raise prices fast enough on gasoline to make up for the difference in the increased cost of their feed stock,’ Pearlman told CNBC.  ‘You’ve seen oil prices go down here 11 percent, but the price of gas has only gone down about 3 percent.’ He says recent price moves will help refiners recapture their pricing power and margins.”

We do, of course, agree with that assessment. But the tide may already be turning. Insiders and hedge funds have been moving into position to profit… from a dramatic DROP in crude prices… since May!

Oil may still be trading around $125 a barrel. But signs of a trend reversal are popping up everywhere: Energy prices aren’t going up. They’re going down. Fat-cat insider bets prove as much – and when they turn out to be correct, you could make a bundle! Just how much? Depending on just how low oil will go, you could see gains of 50… 60… or even 75% by November 1!
 
But let’s review the evidence

Some of the world’s biggest hedge funds are now quietly betting on a turnaround… by stocking up on beaten-down U.S. refinery stocks:
* Bruce Koyner’s $12 billion hedge fund just increased its shareholdings in six refiners, including Valero, Tesoro and Sunoco.
* Citadel, a $22 billion fund, quietly sequestered an incredible 192,610 shares of Tesoro and increased its stake in Holly almost eightfold to 190,681 shares in the first three months of 2008.
* Renaissance, a $30 billion fund, just bought 609,888 shares of Valero and increased its existing stake in Calumet by 5.3%.

But it’s not just hedge funds that are betting top dollar on a turnaround in crude oil prices: Refinery executives are buying more of their own stock than at any time in the past eight years! Oil and gas processors have experienced a 40% decline in share prices since January after crude oil prices gained 43%. That’s the largest drop since 1995.

But it’s not really surprising when you consider that profits of U.S. refiners plummeted an incredible 98% in the first quarter after companies were unable to make up for higher crude prices with higher gasoline, heating oil and jet fuel prices.

Now, earlier this year, chief executive officers, directors and other senior officials of oil refineries had been dumping their shares like there was no tomorrow. After all, they knew that if oil prices went up, their margins would go down. Suddenly, things have changed: Executives at 10 refiners gobbled up $2 million of their own companies’ shares in May… that’s twice the amount they had sold!

One of these insiders is Irl Engelhardt, chairman of the Federal Reserve Bank of St. Louis, who has put $509,000 of his own money into Valero… a battered refinery stock. The logic is quite simple: Refineries have been unable to pass higher crude oil cost on to customers. (If they could do that, you’d be paying $6 for gas!)

So any drop in crude prices means increasing margins for refiners. Which will mean higher share prices!

* Tesoro director John Bookout III increased his insider stake by 58%.
* Calumet Specialty Products Partners CEO William Grube bought 50,000 shares in May – his first purchases since the company went public in January 2006.

But one company’s management has been buying up shares at an unprecedented clip: The Executive Chairman of the Board bought 53,000 shares of his company for $727,250… at between $12.43 and $14.74 a share. Even better, the refiner’s parent company acquired a whopping 880,000 shares for $11.4 million… paying between $12.03 and $14.79 a share.
 
Insider buying is good… but increasing output is better

Now… insider buying often is a bullish indicator. But their betting on lower oil prices alone would not be sufficient for us to recommend this stock… even though right now, you can buy it for under $14. The thing is, this company’s stock price has been depressed artificially since February due to an incident at one of its plants that knocked out part of its capacity.

An estimated 70% of the company’s consolidated EBITDA was produced by this very facility in 2007. It is now working at 50% of capacity… but the company estimates it will be fully back online in late July.

There is another catalyst that could send the stock price soaring in the very near future. You see, the company has just completed the acquisition of another facility, which will increase its output by another 50%! The stock is currently trading at a 73% discount over its July 2007 high. The Hot Stock Confidential team has given it a conservative 67% upside by November. (I have included a detailed briefing on this rebound play, as well, in Special Research Report, 3 Recession-Busting Stocks You Need To Buy Now.)

News that a major bank just increased its holdings in this stock from under 95,000 to over 150,000 shares sent the stock price up almost to our buy limit last Wednesday. You may have missed our initial recommended entry level. But you’d still be in an almost perfect position for explosive gains by December if you buy now.

Overall, playing oil refiners in expectation of further drops in the crude oil prices may be a tad indirect for your taste. But I think it is time to risk a limited amount of money on the downside of oil.
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Posted by J. Christoph Amberger · Filed Under Oil and Energy 

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