Bakken Shale Play Boosts Margins and Profits for HollyFrontier

An influx of new supplies of oil from the Bakken shale formation and other similar plays has created a pool of ‘trapped’ crude oil that is helping refiners like HollyFrontier Corp. (HFC.N) by pushing down feedstock prices while enabling them to sell their own products at higher global prices.

The boom in shale oil production in various regions across the continental United States has created an intriguing opportunity for crude oil refiners in these regions. For now, at least, the rate at which the process of hydraulic fracturing has opened up new reserves of both oil and natural gas, and the rate at which those are being developed and at which supplies are growing, continues to outpace the rate at which infrastructure to transport and process them has increased. Boosting refining capacity, or enhancing the ability of pipelines to transport crude output to areas where that refining capacity is less constrained, takes time and costs money.

One the beneficiaries of these twin trends is HollyFrontier Corp. (HFC.N), the company formed in 2011 through the merger of Holly Corp. with Frontier Oil Corp. which has refineries in Wyoming, Kansas, New Mexico and Oklahoma, very close to the key Cushing, Oklahoma pricing and transportation hub. As oil production rates not only in the Permian Basin region of Texas but also the Bakkenformation area of North Dakota have soared, the price for midcontinental crude has fallen, giving the company’s refining margins a boost. Currently, there is a hefty price differential between the price for West Texas Intermediate (WTI) crude oil and Brent crude prices, which servce as the global standard of nearly $20 a barrel. HollyFrontier purchases the crude oil it uses as feedstock at the local WTI price, reselling its refined products at levels closer to the Brent price. When HollyFrontier announced its third-quarter earnings last November, it reported that its gross margin for its refinery operations jumped 8.7% from year earlier levels to $30.55 a barrel from $28.10 per barrel previously.

HollyFrontier isn’t the only refiner to benefit from this trend, of course; other potential winners include Tesoro (TSO.N), which we identified last autumn as a company likely to generate a positive earnings surprise in the third quarter.

Analysts haven’t overlooked this trend, and have been busy increasing their earnings estimates for HollyFrontier. Indeed, over the last 90 days, the I/B/E/S consensus forecast for the company’s fourth-quarter earnings (represented by the gold line in the chart below) has risen to $2.06 a share today from $1.36 a share. Nor, it seems, may those upward revisions be at an end, if the StarMine SmartEstimate (represented by the Blue line in the chart below)is any indicator. That fourth-quarter earnings forecast, which emphasizes the most recent analyst estimates and those by the analysts with the best track record for accuracy, today stands at $2.29, giving HollyFrontier a large positive Predicted Surprise of 11%. Of the seven revisions to the company’s fourth-quarter earnings estimates announced by analysts since December 1, six have been increases. The sole analyst to cut his estimate still is forecasting that the company’s profits for the just-ended fourth quarter will prove to be higher than the current mean forecast. The odds favor other analysts increasing their own outlook for the company’s earnings as the clock ticks down toward its reporting date on February 25.

Analysts’ optimism isn’t confined to HollyFrontier’s fourth-quarter results. Many have increased their outlook for earnings and revenue for 2013 as well, sending the mean estimates higher. HollyFrontier scores 99 out of a possible 100 on the StarMine Analyst Revisions Model (ARM) indicating that analysts’ views of the company’s earning potential remain intact and that higher estimates are likely to be forthcoming in the coming weeks and months.

HollyFrontier’s stock price reflects a lot of this optimism, having soared from $25 about a year ago to a recent high of $45 a share. Some of this improvement in earnings certainly has been priced in, begging the question of whether the company has now become too expensive? The answer to that appears to be a firm ‘no’, at least when HollyFrontier is evaluated using the StarMine Relative Value (RV) model. The company scores an 86 out of a possible 100 on that scale, signaling that company’s earnings potential has improved even as its share price has rallied. That valuation is reflected in the company’s price/earnings ratio: at its current levels, HollyFrontier trades at a mere 7.4 times forward 12-month earnings, well below the 10-year median of 10.9. To the extent that analysts continue to boost their earnings estimates, that valuation could merely make the stock look still more attractively priced at its current levels.

The process of ‘fracking’ may remain politically controversial, given the potential environmental impacts that its critics highlight. But for now, the ability to extract large quantities of formerly inaccessible reserves of oil and natural gas may be even more of a boon to strategically-located refiners like HollyFrontier than they are to the exploration and production companies that are busily ramping up their development programs in regions like the Bakken shale formation.

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