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WNR AT A GLANCE

P/E ► -1.53   EV/EBITDA ► 89.2 VERY HIGH ROA ► -4.6% AVG ROE ► -32.9% AVG Debt to Equity ► 2.73 HIGH Current Ratio ► 1.48 HIGH Interest Coverage Ratio ► -1.18 LOW

 

 

 

 

 

 

Western Refining (NYSE: WNR) owns and operates four oil refineries in the Southwest United States, with a capacity of 234,000 barrels per day (bpd). Western Refining's profits are determined primarily by the cost of refining crude-oil and the prices at which the Company can sell those refined products. However, higher cost crude oil, which peaked at $145.85/barrel in July 2008, have lowered the Company’s profitability in the first half of 2008. By September 30, 2008, oil and gasoline prices began dropping as a result of lower energy consumption in the consumer and manufacturing sectors. In the first three months of 2009, lower crude prices have improved the profit Western Refining's makes from producing petroleum products.^[1] As a result of better refining margins in 2009, Western Refining has not reduced significantly its overall daily production.^[2] Lower gasoline prices could also reduce incentives for consumers to use alternative forms of energy, which have the potential to reduce the sales of refined products in the United States. However, Western Refining has increased the amount of cheaper, low-grade crude oil that its refineries can process in anticipation of higher crude prices and lower profit margins in the future.^[3]

Western Refining faces new competition from Gulf Coast oil companies, which have begun to supply the Southwest United States through the Longhorn Pipeline. Currently, the pipeline can deliver up to 72,000 bpd of unleaded gasoline and diesel, but pipeline expansions will increase Longhorn's capacity to 225,000 bpd.^[4] Increased competition will reduce the price of refined products in this region. ^[5] In response,Western Refining has expanded its refining capacity through acquisitions of other independent refiners. In particular, Western Refining’s 2007 purchase of Giant Inc. doubled their refinery capacity. Western Refining paid for the acquisition of Giant’s New Mexico and Virginia refineries with a $1.5 billion loan. As credit becomes harder to acquire and profits become lower, Western Refining will have difficulty expanding in the future.

Company Overview

Net sales for , 2008 were 46.8% higher compared to net sales 2007. The increase in net sales was primarily the result of increased capacity from the Giant acquisition as well as higher sales prices for refined products, particular at the company's El Paso Refining. The average sales price at the El Paso refinery increased from $89.38 in 2007 to $113.62 in 2008. Cost of products sold for 2008 increased 52.9% compared to in 2007. While sales prices increased at the El Paso refinery, so did the cost to make refined products. The average cost per barrel at the El Paso refinery increased from $72.38 in 2007, to $102.77 in 2008.

Refining margins improved in the first quarter of 2009 as a result of lower crude prices.^[6] The company's refining margin was $13.59/barrel in the first quarter of 2009, about $8.00 higher than the refining margin for the same quarter in 2008.^[7] Due to better refining margins, earnings in the first quarter of 2009 increased to $58.9 million from $40.4 million for the first quarter of 2008.^[8] Although many of Western Refining's competitors have reduced their overall production in 2009 in response to lower demand for gasoline, Western Refining's production declined less than 1% in the first quarter of 2009 when compared to the same quarter for 2008.^[9]

In the second quarter of 2007, Western acquired Giant Industries, Inc., the merger raised the firm's production capacity from around 124,000 bpd to 223,000 bpd. In the U.S. refining industry, expansion occurs through acquisition and equipment upgrade, rather than through refinery construction; no new refineries have been built in this country since 1976. Western has achieved much of its recent expansion by upgrading its processing equipment to refine light, sour crude, as well as through the acquisition of Giant.^[10]

Source: WNR 2008 10-K Report ^[11]

Western Cannot Refine Cheaper Crudes

Western's refineries have refining capacity that can handle 50% light sour crude, a form of crude that trades $5 lower than the norm: light, sweet crude^[12]. Major refiners on the Gulf Coast, like Valero, can refine heavy sour crude, which is much cheaper than light, sweet crude (trading in the fourth quarter of 2007 at $14 less than the WTI price^[13]). Refining heavy sour allows the larger refiners to produce at lower cost and sell at lower price, creating price competition for Western and depressing its margins in two directions: from below, as Western's inputs are more expensive, and from above, as Western must lower prices to compete.

Business Segments

Refining Segment(85.2% of 2008 Operating Income)

Western Refining owns four refineries, which make various grades of gasoline, diesel fuel, jet fuel, and additional products from crude oil and other feedstocks. The four refineries are located primarily in the Southwest United States: one in El Paso, two in the Four Corners region of New Mexico, and one in Yorktown Virginia. With production capacity of 124,000 bpd, Western Refining’s El Paso site is its largest producer of crude oil. Each of these refineries has its own distribution centers and sells these products to service stations, independent wholesalers and retailers, and other energy companies.^[14] Sales to Chevron Products Company composed 10.8% of 2008 consolidated sales. 91.7% of consolidated sales in this segment came from domestic sales in the United States. The remaining 8.3% of 2008 consolidated sales were to PMI Trading Ltd., an affiliate of Petroleos Mexicanos.^[15]

Net sales in this segment increased by 47.4 % to $10.45 billion in 2008 primarily because of increased production capacity, higher sales from its El Paso refinery, and a higher price of crude oil. Western Refining’s daily production increased by 19.6% due to the acquisition of Giant’s refining sites in the second quarter of 2007 and increased production at the El Paso refinery. While sales prices increased in 2008, the cost/barrel at the El Paso refinery increased 42% as a result of rising oil prices in the first half of 2008^[16] For 2008, intercompany transactions reduced net sales by $1.756 billion.

Wholesale Segment(9% of 2008 Operating Income)

Western Refining’s wholesale segment owns several lubricant and bulk petroleum distribution plants. It sells commercial wholesale petroleum products in Arizona, California, Colorado, Nevada, New Mexico, Texas and Utah. This segment purchases fuels and lubricants from the Company’s refining segment and some third party distributors. The wholesale segment distributes primarily to mining, construction, and transportation industries. The wholesale segment was acquired during the Giant acquisition of 2007. ^[17]

Retail Segment(5.7% of 2008 Operating Income)

Western Refining’s retail segment operates service stations, convenience stores and kiosks in Arizona, New Mexico, and Colorado. The Company’s refining segment supplies all of the service stations with gasoline and diesel fuel. Its service stations and convenience stores sell a variety of merchandise and food products. The retail segment was acquired during the Giant acquisition of 2007.^[18]

Trends and Forces

American environmental concerns have potential to curtail refining output for independent refiners

According to a report published by the American Petroleum Institute, the American Clean Energy and Security Act bill has the potential of leading to a 17 percent reduction in U.S. refinery output by 2030.^[19] The bill creates a cap-and-trade system that control greenhouse gases by creating a market for emissions permits.^[20] Refiners have the potential of paying for emissions in two ways.^[21] First, the cap-and-trade restrictions apply to the refineries, plants, and gas-powered transportation used by refiners to produce and distribute petro-products. Although refiners account for 4% of the greenhouse gas emissions in the U.S., only 2.25% of the permits have been allocated for the refining industry.^[22] Additionally, the cap-and-trade bill has the potential of applying the permit system to the exhaust from automobiles, planes, trains, and heating oil. However, the emissions restrictions do not apply to foreign countries. According to the American Petroleum Institute, the bill is capable of raising the cost of domestic refining to the point where imported gasoline is less expensive.^[23] The study claimed that in its worst-case scenario, the cap-and-trade system has the potential of reducing annual U.S. refining investments by up to $89.7 billion, reduce refinery utilization rates by 20%, and leading to a cut in refinery production by up to 4.4 million barrels a day.^[24]

For U.S. independent refiners, gasoline and diesel margins shrink and inventories grow in 2009

As a result of rising crude prices and relatively low demand for petroleum products, U.S. independent refiners have shifted focus from expansion to cost cutting. In November 2009, crude prices were double their 2009 lows, but demand for fuel has remained low for the year.^[25] As a result, gasoline prices have not increased as quickly or by the same degree as crude, which has meant higher costs and smaller profit margins for most refiners. In an effort to reduce operating costs, many refiners, including Valero, Sunoco, and Western Refining, have temporarily stopped production at many of their refineries.^[26] In addition to tighter refining margins, increases in both fuel efficiency and the number of viable energy alternatives have contributed to relatively low fuel consumption. ^[27]

From 1993 to January 2009, refining capacity rose 17%, but fuel demand has increased by significantly more.^[28] To close the shortage, imports of petroleum-products has increased 93% over the same period.^[29] U.S. refiners have the potential of upgrading their refineries to produce fuel inexpensively and efficiently in order to compete better with more overseas competition and smaller margins. Plant upgrades, smaller profits, and tighter credit markets margins are capable of forcing many smaller refineries out of business as size and scale become vital to reducing refining costs.^[30]

For the second quarter of 2009, Western reported a net loss of $7.8 million compared to Western Refining, Inc. today reported a net loss of $7.8 million, compared to net income of $8.2 million for the same period in 2008.^[31] Lower refining margins due to rising crude prices and less throughput contributed to the net loss during the second quarter of 2009. Western Refining paid off large portions of its outstanding debt from 2007 and 2008 during the second quarter of 2009.^[32]

For the third quarter of 2009, Western Refining reported a net loss of $4.8 million compared to a net income of $109.2 million for the same period of 2009.^[33] Refining margins remained low in the third quarter, but production volumes were stable, suggesting a potential fuel consumption rebound in early 2010.^[34] To combat weak refining margins, Western refining has focused on refinery consolidation and other techniques designed to improve efficiency. In the third quarter of 2009, the Company identified cost savings initiatives that have the potential of reducing operating costs by approximately $25 million.^[35]

The Longhorn Pipeline and Increased Gulf Competition

Completed in 2005, The Longhorn pipeline connects Gulf Coast refineries to the El Paso pipeline, which delivers oil to Phoenix and Albuquerque. As a result, oil companies that operate in the Gulf Coast can cheaply and quickly supply two cities that were, until recently, relatively isolated from Gulf Coast supply lines.^[36] Sales in Phoenix and Albuquerque carry higher profit margins for Western Refining because the company operates service stations in both cities. Pipelines such as the Longhorn pipeline, illustrate Gulf Coast Oil companies’ increasing investment in supplying the Southwest United States and other Western regions with oil. More competition in these cities will reduce the prices of refined products and profit margins for smaller oil refiners like Western Refining.^[37]

However, an expansion on the El Paso-Phoenix pipeline was completed in 2008, and Western Refining won exclusive rights to use this expansion. Due to strict pollution regulations in Phoenix, Gulf Coast Oil companies will have to retool their refineries to meet these standards.^[38]

Oil Prices Are Volatile, and are the Primary Determinant of WNR's Profits

In the second half of 2008, oil prices have dropped close to 72% after peaking $147.27 on July 11, 2008. In the midst of a recession, United States consumers have stopped spending money on gasoline for their motor vehicles while simultaneously manufacturers have reduced the amount of they produced, and therefore the energy they consume, in order to adjust to lower retail and product sales. During October 2008, the difference between the cost of crude and the price of refined products was -$1.86, which means that refiners were losing money on every barrel of crude they “cracked” into gasoline. The historical difference was $20, meaning that a refiner profited $20 for every barrel of crude that it processes into gasoline.^[39] According to analysts, $20 profit per barrel seems unlikely to occur in the next three years.^[40] Although oil is likely to continue to drop as demand for oil and output decline, it is hard to predict what the prices of crude oil and gasoline will be in the future. The extent to which the price of oil falls in the first half of 2009 will be determined by the United State recession, the recession’s effect on China, and OPEC’s response to falling oil prices.^[41] In a December conference, Gulf Oil CEO Joe Petrowski told business leaders that oil could dip to $20 and gasoline prices in the U.S. could fall to a dollar per gallon early in 2009.^[42] Because future oil prices are so volatile, it is difficult to predict revenue and earnings growth for small refiners. 91% of Western Refiner’s 2007 revenue came from sale of refined products, and their profits are determined by the cost of crude and the price they can sell those products. For refiners like Western Refining, plummeting demand and prices make it much more difficult to generate profit from the sale of refined products. With lower margins, Western Refining would have less financial capital to invest in improving current refining infrastructure and expanding the amount of refineries it controls.

Although the extent that to which the global recession will affect the United States economy in the future is uncertain, many analysts, including those at Merrill Lynch, estimate that the price of oil will drop below $30 per barrel in early 2009.^[43] For small U.S. refiners like Western Refining, cheaper crude prices will reduce the costs of producing refined fuel. Nevertheless, prices for gasoline and other fuels are another determinant of Western Refining’s profit. Since October 2008, the price per gallon of gasoline has started to decline more slowly than the price of crude oil, which means that Western Refining has profited for every barrel of refined gasoline it sells during this time. Lower gasoline prices could increase the amount of barrels Western Refining sells because lower prices increase make gasoline more affordable to manufacturers and consumers. Lower crude costs and higher demand for refined products has the potential to boost Western Refining’s revenue and profit in 2009.

The American Auto Paradigm is Beginning to Shift Away from Petroleum

During his campaign, President-elect Obama outlined his plan to increase Government spending on alternative energies like Wind Energy, Clean Coal, and Nuclear Energy in an effort to remove the United States from dependence on foreign oil. In addition, Obama also outlined Government initiatives to reduce gasoline prices for consumers. Barack Obama's election will likely lead to increased investment in alternative fuels and a push toward electric or ultra-high efficiency cars.^[44]As gasoline becomes more affordable for consumers and manufacturers, Government officials and investors will be less likely to make alternative energy their investment priority. However, analysts at Merrill Lynch also predict that crude prices will rise to $70 per barrel by 2010. At this price point, many alternative sources of energy and fuel remain cost-effective.^[45] In addition, the outcome of the Big Three Detroit automakers' crises has the potential to increase the fuel economies of all their vehicles, as this is likely to be a condition for government support of a bailout. Investments in better fuel mileage and alternative energies therefore will likely decrease gasoline consumption in the United States and reduce sales of gasoline for Western Refining.

Western Refining could be one of the hardest hit by a shift toward alternative fuels - in 2007, over 91% of the company's refining capacity went toward producing light fuels like gasoline, diesel, and jet fuel: 52% of this was gasoline, 38% was diesel and jet fuel.^[46] A reduction in the demand for gasoline that an increasing national fuel economy would create could greatly reduce the price of gasoline; the replacement of diesel by biofuels would have the same effect. In both cases, falling prices would put heavy pressure on Western's margins.

Acquisition of Giant and Debt has Long-term Effects

In order to acquire Giant Industries, Inc., Western Refining took a $1.125 billion secured term loan. If refining margins continue to shrink, Western Refining will have trouble paying this loan.^[47] In addition, Western Refining received 82% of 2007 revenue from its four refineries, and 50% of 2007 revenue from its refinery in El Paso. Events such as fires, accidents, terrorism, or natural disasters would severely hurt total refining capacity. Giant's refineries suffered three fires in two years, most recently in December 2006.^[48]

The 2008 Financial Crisis will hurt debt-heavy companies like Western Refining. As of the third quarter 2008, Western Refining had $1.47 billion in long-term debt and a debt ratio of .43. Interest expense for the nine months ended September 30, 2008 and 2007, was $69.8 million and $31.9 million, respectively. The increase primarily was due to an increase in outstanding debt as a result of the Giant acquisition in the second quarter of 2007.^[49] As borrowing money becomes more difficult for companies with a substantial amount of debt, Western Refining will have to divert more of its cash flow to pay its current debt obligations. For 2008, Western Refining paid $61.3 million in cash to cover the interest on its long-term debt. As a result, Western Refining will have less cash available for investment in better capital and acquisitions.^[50]

In June 2009, Western Refining took several steps to raise money to pay back its term loan credit agreements. Western Refining has the potential of making a private offering of approximately $600 million in senior secured notes due 2017 and $200 million in convertible senior notes.^[51] The refiner plans to also offer common stock.^[52] Through acquisitions and equipment investments, Western Refining took on a substantial amount of debt.

Competition

Alon USA Energy, INC (ALJ): Alon US Energy is an independent refiner and marketer of petroleum products in the South Central, Southwestern, and Western Regions of the United States. The Company operates in three segments: refining, asphalt, and retail. Alon operates two refineries in Texas and two refineries in California. Alon’s four refineries have a throughput capacity of 228,000 bpd. ^[53]

Valero Energy Corp. (VLO): Valero Energy operates 17 refineries located in the United States, Canada, and Aruba with a total throughput capacity of 3.1 million bpd. In the United States, Valero distributes its refined products in the Gulf Coast, Mid-Continent, West Coast, and Northeast. Its also owns retail stores in all of these regions of the United States.^[54]

ConocoPhillips (COP): ConocoPhillips is an integrated energy company operating in six segments: Exploration and Production, Midstream, Refining and Marketing, Lukoil investment, Chemicals, and Emerging Businesses. It operates primarily in the United States, Canada, Norway, the United Kingdom, and Indonesia. In the United Sates, ConocoPhillips is the second-largest refinery operator. It has refining throughput capacity of 2 million bpd. Additional revenue comes from a midstream natural-gas gathering system and a 20% stake in the Russian energy company Lukoil.^[55] Conocophillips does not have a significant presence in the Southwestern United States and is not one of the Gulf Coast oil companies that uses the Longhorn pipeline.

Holly Corp. (HOC): Holy Corp. is a United States-based petroleum refiner. The Company operates two oil refiners and distributes its refined products in the Southwest and West United States. Holly Corp. also owns 900 miles of crude oil pipelines located in Texas and New Mexico. the Company transports asphalt and liquid petroleum gas(LPG) to wholesalers and LPG retailers.^[56]

(1) Latest data is for 2007

Notes

1. ↑ Western Refining Reports First Quarter 2009 Financial Results, May 2009
2. ↑ Western Refining Reports First Quarter 2009 Financial Results, May 2009
3. ↑ Western Refining Reports First Quarter 2009 Financial Results, May 2009
4. ↑ Longhorn Pipeline: Fact Sheet
5. ↑ WNR 10-K for 2007
6. ↑ Western Refining Reports First Quarter 2009 Financial Results, May 2009
7. ↑ Western Refining Reports First Quarter 2009 Financial Results, May 2009
8. ↑ Western Refining Reports First Quarter 2009 Financial Results, May 2009
9. ↑ Western Refining Reports First Quarter 2009 Financial Results, May 2009
10. ↑ CNNmoney.com: Behind High Gas Prices, the refinery crunch
11. ↑ WNR 2008 10-K
12. ↑ Morningstar Report, Western Refining, Inc., 8-27-2007
13. ↑ VLO 4Q07 Earnings Call, Page 2
14. ↑ WNR 10-K for 2008, Item 7: Fiscal Year Ended December 31, 2008, Compared to Fiscal Year Ended December 31, 2007
15. ↑ WNR 10-K for 2008, Item 7: Fiscal Year Ended December 31, 2008, Compared to Fiscal Year Ended December 31, 2007
16. ↑ WNR 10-K for 2008, Item 7: Fiscal Year Ended December 31, 2008, Compared to Fiscal Year Ended December 31, 2007
17. ↑ WNR 10-K for 2007, Item 1: Wholesale Segment, pages 9-10
18. ↑ WNR 10-K for 2007, Item 1: Retail Segment, page 9
19. ↑ Allbusiness.com: Oil refiners: Cap-and-trade will cost, September 2009
20. ↑ Allbusiness.com: Oil refiners: Cap-and-trade will cost, September 2009
21. ↑ Allbusiness.com: Oil refiners: Cap-and-trade will cost, September 2009
22. ↑ Allbusiness.com: Oil refiners: Cap-and-trade will cost, September 2009
23. ↑ Allbusiness.com: Oil refiners: Cap-and-trade will cost, September 2009
24. ↑ Allbusiness.com: Oil refiners: Cap-and-trade will cost, September 2009
25. ↑ Market Watch: Dismantling the U.S. refining Sector, November 2009
26. ↑ Market Watch: Dismantling the U.S. refining Sector, November 2009
27. ↑ Market Watch: Dismantling the U.S. refining Sector, November 2009
28. ↑ Market Watch: Dismantling the U.S. refining Sector, November 2009
29. ↑ Market Watch: Dismantling the U.S. refining Sector, November 2009
30. ↑ Market Watch: Dismantling the U.S. refining Sector, November 2009
31. ↑ WSJ: Western Refining Reports Second Quarter 2009 Financial Results, August 2009
32. ↑ WSJ: Western Refining Reports Second Quarter 2009 Financial Results, August 2009
33. ↑ cspnet.com: Tesoro Reports Third-Quarter, Nine-Month 2009 Earnings, November 2009
34. ↑ cspnet.com: Tesoro Reports Third-Quarter, Nine-Month 2009 Earnings, November 2009
35. ↑ cspnet.com: Tesoro Reports Third-Quarter, Nine-Month 2009 Earnings, November 2009
36. ↑ Longhornpipeline.com: Facts About Us
37. ↑ Morningstar.com: Analyst Report for WNR, March 2008
38. ↑ Morningstar.com: Analyst Report for WNR, March 2008
39. ↑ Kiplinger: Oil Refiners: Cheap for a Reason
40. ↑ WSJ.com: Oil’s Slide Set to Leave Dark Trail
41. ↑ Seekingalpha.com: What is the long-term impact of Weak Oil prices?
42. ↑ seekingalpha.com: What is the Long-term Impact of Weak Oil Prices
43. ↑ seekingalpha.com: What is the Long-term Impact of Weak Oil Prices
44. ↑ seekingalpha.com: Energy Investments Under Obama: Eye on Barclays Carbon ETN
45. ↑ seekingalpha.com: How will Temporary Decline in Oil Prices Impact Energy Sector
46. ↑ WNR 10-K for 2007, Consolidated Financial Statements: Refining Segment, page 41
47. ↑ WNR 10-K for 2007, Company Overview: Acquisition of Giant Industries, Inc., page 30
48. ↑ Morningstar.com: Analyst Report for WNR, March 2008
49. ↑ WNR 10-Q for 3Q 2008, Results of Operations, page 35
50. ↑ WNR 10-K for 2007 Risks: We have a significant amount of indebtedness, page 20
51. ↑ WSJ: Western Refining Announces Offering of Senior Secured Notes , June 2009
52. ↑ WSJ: Western Refining Announces Pricing and Increased Size of Concurrent Common Stock and Convertible Senior Notes Offerings, June 2009
53. ↑ Reuters.com: ALJ
54. ↑ Reuters.com: VLO
55. ↑ Morningstar.com: COP
56. ↑ Yahoo! finance: HOC
57. ↑ E 2007 Annual Report
58. ↑ SUN 2008 10-K, Item 7, Page 35
59. ↑ ^{59.0 59.1} CVX 10-K 2009, Item 1, Page 24
60. ↑ VLO 2008 10-K, Item 1, Page 3
61. ↑ ^{61.0 61.1} XOM 2008 10-K, Item 6, Page 43
62. ↑ RDS’A 2008 20-F, Results, Refining Data
63. ↑ Sinopec Investor Relations, Operational Statistics for 2008
64. ↑ WNR 2008 10-K, Item 7, Page 34
65. ↑ ^{65.0 65.1} COP 2008 10-K, Item 1, Page 16
66. ↑ ^{66.0 66.1} BP 2008 20-F, Item 1, Page 29
67. ↑ Lukoil Investor Relations – Fact Book 2008, Page 15
68. ↑ Conversion factor is 1 BPD = 50 tonnes per year
69. ↑ ^{69.0 69.1 69.2} TOT 2008 20-F, Item 4, Page 36
70. ↑ SUN 2008 10-K, Item 1, Page 1
71. ↑ ^{71.0 71.1} VLO 10-K 2008, Item 1, Page 1
72. ↑ RDS’A 2008 20-F, Results, Manufacturing
73. ↑ Sinopec Refining Overview
74. ↑ WNR 2008 10-K, Item 1, Page 19
75. ↑ Lukoil Investor Relations – Fact Book 2008, Page 16
76. ↑ SUN 2008 10-K, Item 1, Page7
77. ↑ CVX 10-K 2008, Item 1, Page 25
78. ↑ CVX 10-K 2008, Item 1, Page 26
79. ↑ XOM 2008 10-K, Item 2, Page 25
80. ↑ RDS’A 2008 20-F, Results, Marketing
81. ↑ Sinopec 2008 Annual Report, Business Review and Prospects, Page 20
82. ↑ WNR 2008 10-K, Item 1, Page 3
83. ↑ COP 2008 10-K, Item 1, Page 18
84. ↑ BP 2008 20-F, Item 1, Page 30
85. ↑ Lukoil Investor Relations – Fact Book 2008, Page 60