Analysis, Featured, Trading Ideas,

Why I’m Long Valero and Tesoro

Overview

In 2015, Valero ($VLO) and Tesoro ($TSO) were the darlings of Wall Street and recommended almost daily on CNBC. The two oil refiners benefited from the low prices of oil, and their stock prices shot up as a result. However, come 2016, the two stocks have sold off quicker than girl scout cookies outside a marijuana store in Denver.

Year-to-date, their shares are down 18 percent and 28 percent respectively, and nobody is talking about why.

[Disclosure: I have long positions in both VLO and TSO.]

Possible Reasons for the Sell-off

Understandably, Tesoro’s stock has lost value, as its refinery in Martinez, California, and others had to shut down because of a United Steelworks Strike. During this time, Tesoro lost out on revenues from as much as 166,000 barrels of crude oil per day, according to NBC Bay Area. Its stock is trading near its 52-week lows, almost erasing its entire 2016 bullish gain.

Since Tesoro and Valero have a strong correlation of 0.78, Valero’s stock (and stock of other oil refiners) sank alongside Tesoro’s, testing its August flash-crash lows.

The selloff last month might have also been, in part, because of worries over bankruptcy and uncertainty about oil as a commodity export. This time around, low oil prices are being fueled by oversupply and not low demand. Over production can eventually cause stress on refiners. It could also be true that the market was pricing in an unexpected sharp rise in oil prices, which also would hurt refiners (and the economy as a whole.)

I believe Valero would fare okay if oil prices rose sharply or if the overproduction problem did not correct itself. Its balance sheet and international footprint would work in its favor. Tesoro, a smaller company, is a bit more skeptical.

Some investors are reluctant to buy shares in these two companies because of the uncertainty around OPEC’s stance. On 23 February, the Saudi Arabian Oil Minister said they will not cut production because Iran won’t promise to cut. Oil futures tanked. Last week, OPEC said they would cut production and the WTI Crude and ICE Brent soared. The balance sheets of these two companies offer flexibility that other companies don’t have. This makes them more likely to be able to adapt no matter what OPEC ultimately ends up doing.

Fundamentals

Both companies are healthy, and their fundamentals show that a selloff of this proportion is overdone. Both stocks are likely poised for a recovery. Valero has one of the strongest balance sheets in the entire oil sector, with $16.8 billion in current assets and $1 billion in free cash flow to cover its $8.3 billion in current liabilities. Trading at a P/E of 6.3, Valero is cheap, even in comparison to the industry average of 8.4.

Unlike some of the larger oil companies, Valero’s dividend is very safe with that balance sheet to back it up. Some analysts have taken issue with Valero’s junk credit rating, but it’s not an issue because Valero will not need to raise cash any time soon. In addition to Valero’s large dividend, it is a serial stock-repurchaser, which benefits shareholders and gives Valero an increasing quantity of treasury stock as an additional tool to raise capital if the need arises.

Tesoro’s balance sheet is less remarkable, but with $5 billion in current assets to cover $3 billion in current liabilities, it’s not in financial distress either. Couple that with the fact that Tesoro has $1.05 billion in free cash flow, the highest it has had in five years, and there is a possibility of an upward revision to earnings or surprise earnings beat in May. Tesoro currently trades at a P/E of 5.5, making it even cheaper than Valero.

In 2015, betting on these two stocks paid off because, as refiners, they benefit from cheap oil, but they will probably be a good bet in 2016 for a different reason. Outside of Chevron and Exxon Mobil, the refiners are the companies with balance sheets that can support purchasing marked-down assets from other oil and natural gas companies at risk of bankruptcy. Both Valero and Tesoro make acquisitions regularly in order to achieve growth.

Technicals

Technical traders, otherwise known as “chartists” have loved Tesoro in particular because it trades according to the Dow Theory rules they have adopted to dictate their portfolio decisions, and it had very few pullbacks in price, making it hard to find a bad entry into the stock.

That is, until January. Ten days into 2016, technical traders might have seen the dreaded reversal pattern forming on Tesoro’s chart: a head and shoulders. The pattern was confirmed on January 19, when it broke below the “neck line.” When technical traders see this pattern, they sell or go short. Looking at several thousand instances all the way back to 1929, there is a 70 percent probability that the price is going to fall when this pattern presents itself on a chart.

TSO chart

Both Valero and Tesoro have confirmed technical reversals, and the charts indicate they may be ready to explode upward. The purple chart below the volume is the relative strength index (RSI). Tesoro stock has just popped out of an “oversold” rating, which indicates that there is heavy buying, as confirmed by the volume.

The bottom chart shows the Moving Averages Convergence Divergence (MACD). When the blue line or “signal” crosses over the orange line, it’s a good sign for the stock and indicates heavy buying.

vlo chart

As its chart shows, Valero has moved in tight correlation with Tesoro and is also now on its way back up with similar signals on its chart. Their recovery will probably be fast because on top of the technical and fundamental traders both having a reason to buy the stocks (which hardly ever happens), the Fibonacci traders will also find the two stocks appealing at this price.

Fibonacci Confirmation

Even rarer than fundamental analysts and technical analysts having the same position is when the Fibonacci folks also shake their heads in agreement.

Fibonacci traders make money looking for significant pullbacks in stocks that hold at a certain level. The two most popular levels to look for are 50% retracement and 61.8% retracement. In this case, both securities have retraced to 61.8% over a two-year chart, and they have held that level, as indicated by their mathematically confirmed reversals.

This is a dream for Fibonacci traders and a positive sign for the stocks, indicating that people are noticing how horribly undervalued the stocks are and are taking their own piece of the profits.

Since the stocks are not as popular in the media anymore, we can assume that this is smart money buying and not everyday investors. Therefore, by getting into the names now, an everyday investor might be able to get ahead of the class, so to speak, and score additional profits that are usually only earned by sophisticated Wall Street buyers.

Look out for a rapid upward change in price. When these three classes of traders and investors all agree and buy the same securities at the same time, who is selling? Possibly nobody.

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J Rae has been interested in finance since age eight when her grandfather, who started investing in the 40s, started coaching her. She has been an investor since 2006 and a trader since 2013 and focuses on a diversified portfolio of stocks and options. J Rae has almost completed an MBA in Financial Management.

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