Here is FTO's NOI and the same refining margin model that we developed earlier:
and when we adjust the model for industry refinery utilization and seasonality, we arrive at the following:
In fact, when you do the regression analysis, FTO's net operating income is even more strongly correlated to the refining margins than VLO's was. R-squared was 0.82, compared to Valero at around .66.
Based on the model, we would then expect them to benefit even more than VLO from the current improvement in refining margins, which as of a week or so ago were getting into the $11 per barrel range, and if you plug in the same assumptions we did earlier into FTO's NOI equation, you get earnings of about the same level as they saw in the the fourth quarter of 2006, or the first quarter of 2008, when they were earning somewhere in the mid-40's per share.
But, the consensus of the analysts right now are for earnings in the upper 20-s. What's happening?
If you look at the periods of time they deviated from the model, the second quarter of 2008 and also, really, the last two quarters, and review their management statements these are both periods during which they were experiencing some maintenance issues at their refinery in Cheyenne.
FTO is a lot smaller company. They do not have retail locations, a pipeline network, or any other noticeable diversification, and make their money, or not, on the basis of how good of a job they do of keeping their refineries running. Their Cheyenne refinery makes up 1/3 of the company's total capacity, and they are doing a lot of work to make this operation more efficient and deal in a better way with heavier crude oil.
So, in a real sense, the ability of FTO to get back to what they have been historically doing comes down to the ability of somebody to turn a wrench. Makes you want to give the maintenance people a little more respect doesn't it? Actually, it makes you want to invite the maintenance people to the next earnings conference call to find out how the work is going. It would not be completely unheard of for these guys to be overachievers and get their work done a little faster, and one of the analysts is actually optimistic that this can be done, and they will end up in the 40's somewhere for earnings this quarter.
The last question is: What would be the better investment, FTO or VLO? Well, at a price of 18 and expected earnings this year of about $1 per share, VLO is the less risky of the two. With a current price of 14 and earnings prediction in the mid $0.20-s, FTO is a bit more expensive right now. The possibility of a pleasant surprise for FTO is already in the price.
Keep in mind, of course, that the market does not always care how much money a company is making, and NOI does not always transfer down to EPS because of write offs, and various other things that are going on in a company, including where the refinery is, and what your prediction is going to be for refinery margins and crude oil pricing.
But, in this case, what we really need is the phone number of FTO's Cheyenne maintenance shop. If it rings and someone picks up, it means they have spare time to answer the phone, and things are nice and peaceful, which, if you are a maintenance guy, means you are good at doing your job. If it rolls to voice mail, it means they're busy. That can't be good, in this case.
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