Beware of This Widely-Held Company’s Move Away from Diversity
There’s a lot of talk about diversification and asset allocation on this website, and rightly so. While diversification can limit large short-term gains, it also protects against large short-term losses. Since the markets tend to be unpredictable, it’s the best way to invest long term.
This stratagem is true for companies, as well. If one area of the business performs poorly, there should be another that picks up the slack, and vice-versa.
So if diversification is good, why are these companies turning in the opposite direction?
Oil Refinery Stocks Are Hot
The refinery arm of ConocoPhillips is said to be slightly larger than the current U.S. leader, Valero (NYSE: VLO). Valero had a nice year, as did most refinery stocks. Although it’s nowhere near the highs it reached in the middle of the 2000s, Valero’s value has increased more than 50 percent since last August.
Sunoco (NYSE: SUN) also had a solid 2011. Its stock value is about 25 percent higher than last August. And Tesoro (NYSE: TSO) is up more than 50 percent from last fall.
This refinery boom doesn’t seem to make much sense though, considering worldwide overcapacity and a lower demand for oil in the United States.
It’s All About the Crack Spread
Refineries are doing so well right now because of high crack spreads. In simple terms, the crack spread is the difference in the value of the raw material (crude oil) and the value of the processed good (gasoline, kerosene, etc.). It’s basically the profitability of refining oil. Right now, the crack spread is about $34, its highest level in years.
The table below shows the movement of this crack spread over the past year.
So Why Get Out Now?
Crack spreads are very volatile and have been atrocious throughout the last few years. Just last year, low spreads caused big losses for energy companies. Since 2008, some spreads were even negative due to the high price of crude and the low demand for gas.
Many big oil companies are either cutting back their refineries or getting rid of them all together.
While the refining business has produced a bunch of growth over the past year, companies like Marathon and ConocoPhillips are now trying to achieve stability. By separating the refinery business, they can let the volatile “downstream” sector of their business go and focus on the “upstream” exploration and production business.
With lower U.S. demand and the overcapacity of refineries, the crack spread is bound to fall. These companies are maximizing shareholder value now by splitting the refinery businesses at a premium. This is a shrewd move to increase value over a short period, but the lack of diversity of the business may expose it to future problems.
Beware the Crack Spread and Stick with Diversity
There may be some money to be made as the stock splits into two companies, but beware of the volatile nature of the refinery companies and the crack spread, and also the lack of diversification of the new upstream-only companies.
For more stability look to oil companies that are still comfortable being integrated, such as ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX). Even British Petroleum (NYSE: BP) may be safer, although there are already whispers about them pulling a move similar to ConocoPhillips.
– Justin DoveSource: Investment U
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