Carl Icahn may have a point.
The activist investor has spoken out against the government's longstanding mandate forcing refiners to blend a certain amount of ethanol (or other biofuels) into their gasoline. It's not that he is against biofuels per se but sympathizes with the many small merchant refineries that lack the capability to handle them.
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Those without the necessary equipment must purchase what are called renewable identification numbers (or RINs) from larger rivals who possess the blending capacity. These credits can be quite costly. So, Icahn has proposed shifting the burden from refineries who make the fuel to retail gas stations who sell it.
Of course, this policy may have something to do with the fact that Icahn has substantial holdings in the refinery sector. In fact, the potential conflict of interest is one of the reasons he stepped down from an advisory role in the White House.
So even refineries that weren't given waivers are still benefiting from the lower costs to stay in compliance.
Meanwhile, this favorable regulatory reversal comes at a time when refinery profits in many parts of the country were already building because of widening "crack spreads" (the difference between the cost of raw materials going in and the market value of finished goods going out). That's largely due to transportation constraints in the Permian Basin in western Texas and southeastern New Mexico, where the lack of pipeline capacity has led to discounted prices.
Right now, Permian Basin crude can be purchased for $9 per barrel less than national benchmark prices -- pure profit for refineries with access to it.
That includes HollyFrontier (NYSE: HFC), whose facility in nearby New Mexico processes 100,000 barrels of Permian crude per day. The company reported $309 million in refinery operating income last quarter, versus a loss of $94 million a year ago. And that stronger environment is clearly evident in the stock, which has climbed from the lower $40s to the upper $60s over the past two months -- increasing the return to 144% over the past year.
With an average yield of 2%, HFC really isn't on my radar. But here are three high-yield downstream energy peers to consider.
The Big Boys' Pick
Of the group, CVRR (NYSE: CVRR) is in the best position. Apparently, Mr. Icahn agrees, which is why he owns 5.7 million shares, a stake worth more than $100 million. Other big institutional owners include the likes of Goldman Sachs, Morgan Stanley and JP Morgan.
The aforementioned biofuel waivers have had a tremendous bottom-line impact. CVR was initially planning to spend $200 million on RINs this year, but now expects to pay just $80 million for the renewable fuel credits. Meanwhile, the firm's refinery profits have increased to $13.77 per barrel, up from $11.54 per barrel a year ago – a meaningful increase when you're running 178,000 barrels through the system every 24 hours.
As a result, the company hiked its quarterly distribution to $0.51 per share last quarter. That puts the annual dividend at $2.04 per share, for a hefty double-digit payout. Keep in mind, though, that CVR has a variable distribution policy, so dividends aren't fixed and will change with underlying profits.
But right now, that's a good thing.
Despite advancing more than 50% since the beginning of April, the stock is still trading at just six times EBITDA – a reasonable price for a business expected to deliver triple-digit profit growth this year. I believe CVR is a strong takeover candidate, as similar rivals have been acquired at much richer multiples.
While refinery margins are cyclical, the tight pipeline capacities (and thus wide crude price differentials) are expected to be the norm throughout 2018 and into 2019. The stock is vulnerable to profit-taking on down days, but I believe there is more upside ahead.
This Is Just A Start
The goal of my double-digit stock screen is to identify stocks that might be well-suited for my High-Yield Investing portfolio. But like any quantitative tool, this screen should not be used in isolation. You should also evaluate the fundamental characteristics of every potential investment opportunity. In addition, you should assess how well a particular stock or fund matches your investment needs. And do your own due diligence on a security to decide if it is right for your portfolio.
If I find a real gem within these screens, a stock that can actually maintain this level of yield through the years to come, my High-Yield Investing subscribers will be the first to hear about it.
So if you'd like to join us in our search for the best high yields the market has to offer, then I want to invite you to learn more about High-Yield Investing. You don't have to settle for the paltry yields offered by most stocks. The high yields are still out there. You just have to know where to look -- and my staff and I are here to help you along.
This article originally appeared on StreetAuthority.com.