Stock Analysis & Ideas

These 2 Diesel Stocks are Profiting from Inflation Woes; Can the Upside Last?

Story Highlights

Diesel prices are on an upward trajectory. Yet, that shouldn’t be the only reason to choose a diesel fuel stock to invest in. External tailwinds and internal strengths are a powerful combination that can ensure a company’s sustained growth as well as provide deserving returns on your investments. 

Ever since Russia invaded Ukraine, we have been struck with the unavoidable surge in fuel prices that has made our pockets lighter. A limited supply from Russia, one of the world’s leading oil exporters, and a possible stoppage of supply from Ukraine, another leading oil exporter, led to the surge in fuel prices, which also had a strong hand in adding to the inflationary pressures across the global economy.

Within the fuel domain, the diesel price rise is another much-talked-about matter. Naturally, diesel fuel prices have been on an upward trek, riding along with the rally in the broader oil and gas sector.

The U.S. Energy Information Administration noted that the average prices of ultra-low-sulfur diesel in the U.S. advanced more than 37% in the weeks after the onset of the Russia-Ukraine war, to reach a record $5.62 a gallon by May 9.

Also, the threat of supply outages of diesel, especially on the East Coast, is a matter of grave concern for the market and the American government alike. The Biden administration hinted that it might release diesel reserves, if necessary, in an attempt to calm the soaring prices and the fears of a supply interruption.

It is difficult to say how long this rally in diesel prices will last, given the multiple factors that are influencing the price rise. However, this might be a great opportunity for investors looking into the oil and gas sector to cash in on the uptrend while it lasts.

The success of a stock in this sector does not only depend on the external tailwinds. Rather, strong fundamentals, cash flows, and prospects beyond the short-term highs make a company worth investing in, both for the short as well as the long term.

The following two stocks look very well positioned to make the most of this growth spurt and possibly sustain the momentum in the long run as well.

Suncor Energy (NYSE: SU) (TSE: SU)

Suncor produces synthetic crude from oil sands, which is quite different from conventional oil production. The company is also involved in the exploration, acquisition, development, production, and marketing of crude oil in Canada and internationally.

Suncor is among those that have been benefiting this year from burgeoning oil prices. SU stock has gained 36% in the last three months, handily outperforming the 8% losses in the S&P 500 (SPX) in the same time frame.

Although oil sands extraction projects involve massive start-up costs, maintenance costs drop considerably once the project starts running. Also, the lifespan of oil sand projects is significantly larger than other traditional extraction methods like oil wells, allowing for sustainable cost-control opportunities.

Suncor’s dividend-generating capabilities are also noteworthy. Earlier this month, the company hiked its dividend by 12%, reaching the highest level in its history, after its profits increased more than three times in the first quarter.

The company’s annualized dividend yield is 3.7% currently, which is impressive for investors, at least during choppy times like these when capital gains are difficult to achieve.

Moreover, the intense scrutiny that Suncor is facing from activist investors regarding its operational and financial performance is expected to push the company to improve on its problem areas in order to save its reputation.

Importantly, despite the growing advocacy for clean energy that is expected to slowly transition the sector away from fossil fuels, the change is not going to happen overnight. This gives Suncor ample time to keep generating sustainable cash flows for at least a few decades.

Earlier this month, after announcing its dividend hike, Raymond James analyst George Huang reiterated a Buy rating on Suncor and increased his price target to C$52 from C$50.

Wall Street is fairly optimistic about the company’s prospects, with a Moderate Buy consensus rating based on eight Buys and three Holds. The average Suncor price projection is $40.98, implying 4% upside potential.

Valero Energy (NYSE: VLO)

Leading American oil refinery Valero manufactures and markets transportation fuels and other petrochemical products.

Valero’s diversified refinery base, located throughout the United States, Canada, and the Caribbean, makes it stand out among all independent refiners.

Moreover, the company is the second-largest producer of renewable fuels, including ethanol and renewable diesel, which gives it a huge scope to stay relevant and growing. Notably, Valero makes huge profits from crack spreads and crude barrels that travels through its facilities.

Additionally, fixed costs are relatively stable for downstream sectors, giving plenty of room for refining stocks like Valero to scale their cash flows.

On May 23, Piper Sandler analyst Ryan Todd reiterated a Buy rating on the VLO stock and raised the stock’s price target to $135 from $121. Todd believes that there are more “legs” to refining investment than the market predicts.

Also, a few days prior to Todd’s report, JPMorgan analyst Phil Gresh upped his estimates for the refining unit of Valero. He reiterated a Buy rating on the stock and increased the price target to $142 from $111.

Valero has a Strong Buy consensus rating based on 12 Buys and one Hold. Nonetheless, the average VLO price target is $122.23, implying 4% downside potential.

Bottom Line

With increasing inflation showing no signs of stopping, consumers are largely expected to reserve most of their money for essentials rather than discretionary spending. Fuels like petrol and diesel are considered essential, as people will still need to commute to work and other places.

Moreover, trade with Russia is likely to be limited for a long time now because of the war it waged on Ukraine. This is expected to keep oil prices up, at least in the near-to-medium term. Apart from this, bearing in mind the fundamental strengths of Suncor and Valero, both the companies are expected to keep capitalizing on the current opportunities and those that lay ahead.

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