Tuesday, April 12, 2011

Hedging Gas Price Spike: Should You Buy ExxonMobil or Valero?

Gas prices are skyrocketing – they’re up about 32% or 87 cents a gallon in the last year. Not only do they show no signs of abating, but there is little evidence that consumers are changing their driving habits. Back in 2008 when gasoline hit $4.11 a gallon, consumers started taking public transportation in droves after gasoline prices spiked 30 cents in a month.
So far, the shocking rise in gas prices has not led to a big driving cut back, according to the New York Times. This means that prices will probably surge over the 2008 record and raises the question of how investors can profit. Should they buy stock in an integrated oil producer like ExxonMobil (XOM) or a refiner like Valero (VLO)? The answer: ExxonMobil.
To pick which one, it helps to look at history and the future. To examine history, let's look at how the two stocks performed from January to July 2008, when oil prices spiked to $147 a barrel. For the future, we compare the Price Earnings (P/E) ratio of the two companies to their earnings growth rates. The one with the best historical performance and the lowest Price/Earnings to Growth (PEG) ratio should win this faceoff. As we'll see, the outcome is not completely obvious.
When it comes to historical performance, ExxonMobil held up better. ExxonMobil fell 7% between January and August 2008 from $86 to $80. During that same period, Valero plunged 57% from $70 to $30. I think the decline in both stocks during a time when the price of oil was rising is an important warning to investors that there can be a big disconnect between the price of oil and how equities react to its changes.
A quick comparison of the income statements of both companies during the first nine months of 2008 reveals that ExxonMobil put in a stronger performance. Valero's revenues were up 51% to $100.5 billion but its costs -- mostly oil -- were up 60% to $97.1 billion -- as a result its net income fell 55% to $2.1 billion. During that same period, ExxonMobil did better -- its revenues rose 37% to $393 billion while its costs climbed 37% to $324 billion -- resulting in a 29% net income pop to $37.4 billion.
This analysis suggests that during an environment of rapidly rising oil and gasoline prices, the profits and stock market value of a refiner are more at risk than those of an integrated energy company. That's because as prices at the pump rise, people cut back on consumption even though the price of oil going into the refinery remains high -- thus squeezing refinery margins. Meanwhile, an integrated energy company is more diversified -- and its profits are less volatile.
Despite its inferior performance in 2008, investors seem to be putting a greater value on Valero's shares than those of ExxonMobil. And Valero has the lowest PEG ratio of the two -- I think a PEG of 1.0 means a stock is fairly valued -- suggesting it's relatively cheap. Here's how:
  • ExxonMobil 1.76 on a P/E of 13.7 with 7.8% earnings growth to $8.66 in 2012
  • Valero 1.04 on a P/E of 17 with 16.4% earnings growth to $3.43 in 2012
There is, of course, risk in buying energy stocks now. The biggest risk is that the speculators that are driving up the price of oil could decide to take their profits. After all, those speculators control 81% of the trading volume on the futures exchange. Regulators could easily drive them out by requiring them to boost how much money they must set aside for each contract. And the settling of the conflict in Libya could be the catalyst for such an energy selloff.

I’d guess most of the spike from rising oil is reflected in the stock prices of both companies but ExxonMobil is the safer bet for now.Peter Cohan has no financial interest in Valero or ExxonMobil.


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