HF Sinclair

HF Sinclair's adjusted second-quarter earnings exceeded market expectations. The company continued to benefit from a supply-constrained market, which is pushing global refining margins to record levels. It also announced plans to spin off its lubricants business by the second half of 2027.

Why it matters: US refiners are enjoying a windfall from the combined impacts of the Iran war and the Ukraine/Russia war. Both have severely limited global supply by knocking offline 5 million-7 million barrels of capacity, by management estimates. Realized refining margin soared to $25.95/bbl from $16.50/bbl last year, which drove strong results. Renewable diesel and lubricant margins were also very strong during the quarter. Management reiterated its $7.25/bbl medium-term operating cost goal, but acknowledged it has a ways to go. Costs during the quarter rose to $8.08/bbl from $7.45/bbl last year, due in part to unplanned maintenance.

The bottom line: Our $70 fair value estimate and Narrow Morningstar Economic Moat Rating are unchanged. We include the recent strong market margins in our model but still assume an eventual return to more midcycle conditions in the coming years. We also model a steady improvement in refining operating costs. As long as disruptions in the Middle East and Russia persist, margins will remain well above midcycle levels and shares likely above our fair value estimate. Even if one or both of the conflicts end, refining markets will likely take longer to normalize than the crude markets. We already use a sum-of-the-parts approach for our fair value estimate, so the lubricants spinoff has little impact on it. We currently value that business at $16 per share of enterprise value using a 6 times EBITDA exit multiple. Assuming an 8 times multiple as a stand-alone company, the valuation rises to $19.

 The company confirmed that the process to find a new CEO is ongoing, but it gave no indication of timing.

We are increasing our fair value estimate to $87 per share from $70 after incorporating the latest financial results, including cost improvements, and an updated near-term refining market that has continued to strengthen since our last update, given the wars in the Middle East and between Russia and Ukraine. Our fair value estimate corresponds to a forward enterprise value/EBITDA multiple of 3.1 times our 2026 EBITDA forecast of $5.1 billion. Our valuation remains anchored to a return to midcycle conditions from currently elevated levels by the end of our forecast, leaving our fair value well below current share prices.

Our fair value estimate reflects our updated refining margin deck, which incorporates our long-term outlook for crude differentials. Our long-term outlook for the West Texas Intermediate Brent differential is $5, and for the Louisiana Light Sweet Brent differential, it's $2. We assume long-term Gulf Coast refining margins of $15 and adjust capture rates to reflect asset quality and investment.

Based on current futures curves, we model relatively strong refining market conditions to persist through 2026 before returning to midcycle levels in the later years of our forecast. We expect US refiners to maintain a cost advantage relative to most global peers.

Our fair value assumes HF Sinclair achieves lower per-unit costs as it improves reliability. Management targets operating costs of $7.25/bbl near-term, down from $7.7/bbl in 2025, and $6.50/bbl long-term. We assume it largely achieves this goal by the end of our five-year forecast. Profitability should also improve over time, driven by yield enhancements and reliability investments, which will drive higher capture rates. Our fair value estimate would be much lower if costs and margins do not improve.

Earnings growth should largely come from new renewable diesel capacity reaching its full potential while market margins and credit prices improve from current levels.

Despite recent performance, we think HF Sinclair maintains a cost-advantaged integrated model, earning it a narrow economic moat rating.

Perhaps more than any other refiner, HF’s refining segment benefited from wide inland light crude differentials during the last decade plus, thanks to the position of its refining assets. Before the close of the Sinclair and Puget Sound acquisitions, all HF’s refining capacity was in the midcontinent, meaning its refineries could process either discount light or heavy crude, given the proximity to the source of production. After the acquisition, that is still largely the case, with only 149 mb/d (Puget Sound refinery in Washington) of its 678 mb/d in capacity not in proximity to inland crude production (midcontinent, Rockies, Southwest). HF should continue to benefit, as we project differentials to remain well above historical levels prior to 2010, even as new pipeline capacity comes online. Given the feedstock cost advantage, we think HF’s refining business earns a narrow moat.

The firm also has a crude advantage, thanks to its refineries' complexity and proximity to cost-advantaged feedstock from Canada. Its legacy refining system (excluding Puget Sound) has a complexity rating of 12.1, which allows it to process heavy crude and produce comparable yields of refined product more cheaply than refineries that use only the easier-to-refine, but more expensive, light crude. The two refineries acquired with Sinclair can also access Canadian heavy or inland discount sweet crude.

In our view, the acquisition of the Puget Sound refinery is slightly moat-dilutive. The refinery has a complexity of 9.3 but lacks the level of crude cost advantage of the firm’s other refineries. However, it can process various crudes and can access cost-advantaged Canadian crude. Refining on the West Coast, including the Pacific Northwest, has proven difficult and faces future demand challenges, given high levels of EV penetration. That said, low-carbon fuel standards in the region are ahead of the rest of the country and offer the firm an opportunity to leverage its current expansion into renewable diesel. Also, the price paid was reasonable, suggesting the firm can avoid value destruction assuming margins are in line with historical levels.

We view recent poor performance and high costs as a function of poor operating performance and not indicative of an erosion in its structural competitive advantages. Ultimately, we expect management to improve reliability and reduce costs, preserving returns. However, given its portfolio, HF Sinclair is unlikely to achieve the lower costs of some of its larger, better-positioned peers.

Before the Sinclair deal, HF lacked the downstream infrastructure and retail segment. As a result, it could not create renewable identification numbers to meet the renewable fuel standard and had to purchase about half its obligation on the open market. This exposed HF to high RIN prices, which would weigh on earnings. In this context, we view adding a marketing segment as moat-enhancing even if we might not view retail marketing as moatworthy on its own.

We view HF’s ownership of midstream assets, formerly held in Holly Energy Partners, as moat-accretive. In our framework, crude oil and petroleum pipeline assets are typically moaty assets as they benefit from an efficient scale moat source.

HF’s lubricant and specialties business has delivered uneven performance since its first acquisition and has recorded impairments. Although it has shown an improvement in recent years with more consistent performance, we are hesitant to award it a moat as it is also essentially a commodity business with few competitive advantages. However, we do not see it as moat-dilutive or value-destructive over the long term.

We have incorporated ESG risk into our moat evaluation, but no risk is material or probable enough within the next 10 years to influence our narrow-moat rating. A carbon tax could be implemented, which would likely affect demand, but not in the near term. The firm discloses its GHG emissions and carbon intensity and targets a 25% reduction in 2020 scope 1 and 2 emission levels by 2030.

HF’s investment in renewable diesel addresses potential petroleum product demand destruction while reducing its carbon intensity. It also diversifies its output and protects against RIN purchase obligation costs. It can now produce 380 million gallons annually of renewable diesel after converting its Cheyenne petroleum refinery, installing a renewable diesel unit at the Artesia facility, and adding pretreatment units in Artesia and at the acquired Sinclair, Wyoming, refinery. With Sinclair, it also added a 10 mb/d unit in operation since 2018. With 50% lower GHG emissions, renewable diesel should reduce HollyFrontier’s carbon intensity while delivering IRRs of 20%-30%, suggesting it's moat-enhancing as well.

The Sinclair acquisition adds refining assets complementary to HF’s legacy footprint while adding a marketing business that its portfolio lacked, improving competitiveness.

Investments in renewable diesel should deliver free cash flow and high returns while offering diversification from petroleum, reducing carbon intensity, and generating valuable RINs.

Management will successfully improve reliability and reduce costs, increasing HF's earnings power and driving shares higher.

HF Sinclair's refining operating costs are much higher than those of its peers, and efforts to bring them in line will not be successful, while its diversified model reduces exposure to rising refining margins.

HF’s acquired lubricants business has failed to live up to expectations, resulting in impairment. It might not fulfill future expectations either, potentially necessitating a divesture at an unattractive price.

Growing EV adoption threatens the long-term viability of HF’s refining business given the high portion of gasoline production.