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A Deeply Undervalued Play in the Refining Sector

Two weeks ago before my vacation, my inbox filled with questions surrounding the refining space and CVRR in particular, an MLP that I recommended at its IPO price of $25.  In my columns in OilPrice.com, I've spoken recently about the refiners and the difficulty I thought they would continue to see in the coming months.  I even made the case that the mid-Continental refiners, of which CVRR's 'parent' company CVR Energy (CVI) is one, would in fact be in for the worst case of all the refiners, save for the refiners relying upon crude-by-rail.

So how can I still be favorable towards CVRR with the negative outlook I have towards the refiners and CVR Energy in particular?

The question goes a long way to understanding how fundamentals get translated into trading ideas and how there are often values to be had - even in sectors that are up against it fundamentally. 

Yes, it is true that the disintegrating WTI/Brent spread is putting tremendous pressure on the margins of refiners, particularly mid-con refiners -- it was this that forced the new and horrible guidance from Valero (VLO) in their recent quarterly report to shareholders on EPS -- and we imagine that other refiners are sure to follow with negative reports and outlooks.  CVRR is hardly immune to this; As the Brent/WTI spread goes to parity and beyond, as I think it will, their margins and revenue will also decline, putting their very generous distribution is some jeopardy.

So, am I recommending that this stock be sold? On the contrary. There is nothing in the fundamental outlook for CVRR that isn't already deeply represented in the stock.  In addition the original IPO price was so deeply undervalued to the potential distribution that even slightly weaker margins cannot push the price of shares down much more, in my view.  Add that to the secondary offering about a month ago that was designed to purchase shares back from the parent company and the overwhelming interest of super trader Carl Icahn in the company, and you've got a stock that has been sold off significantly based upon a refinery trade without regard to its individual strengths.  

Let's recap -- The current distribution being delivered by CVRR at $6.32 a share represents over 22% in yearly dividend. With the current environment for the refiners and particularly the mid-cons, that distribution is almost guaranteed to take a cut, although probably not before Q1 in 2014.  The stock has made a run as high as $35, which was more in line with a stable distribution, but with shares closer to the original IPO price, this remains one of the few values in refiner MLP's left. 

My recommendation has also recently included sale of call options against owned shares, a covered call strategy which will offset any cut in the quarterly distribution that's almost sure to come. 

In short, you can dislike a sector fundamentally but still see value in individual issues inside that sector where it exists.  And in CVRR, I still see that value strongly.  Recommended.

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