Zacks Industry Rank Analysis Highlights: American Eagle Outfitters, Darden Restaurants, Sunoco, Tesoro and Valero

Zacks Industry Rank Analysis is written by Charles Rotblut, CFA, Senior Market Analyst for Zacks.com.

This week: Housing and Financial Problems To Last Into 2009

Key Points:

-- The drop in crude has yet to help refiners

-- Crack spreads are being affected by seasonal factors

-- Higher home heating bills could create a challenging holiday shopping season

Crack Spreads

Barring a supply disruption from Hurricane Ike, oil will soon test the $100 mark. This is a psychological level of support, and if broken, would suggest further weakness in crude prices.

In theory, the drop should benefit refiners like Sunoco (NYSE: SUN), Tesoro (NYSE: TSO | Quote | Chart | News | PowerRating) and Valero (NYSE: VLO | Quote | Chart | News | PowerRating) by improving the crack spread.

The crack spread is the difference between the cost of oil (an input) and the price of gasoline and heating oil (outputs). Higher oil prices mean refiners have to charge more for gasoline and heating oil in order to maintain the same level of profitability.

The rapid rise in crude prices that occurred earlier this year and the inability of refiners to fully pass along the higher costs caused crack spreads to tighten severely. As oil dropped from its record highs, conventional wisdom would suggest that the crack spread should widen.

So far, this has not happened.

Seasonal Factors Affecting Margins

Seasonal factors seem to be the reason why the crack spread is not widening. Crack spreads typically weaken this time of year as the summer driving season comes to an end. And that is what is occurring now.

According to calculations published on Bloomberg, crack spreads fell to $7.83 in late August, near their lows for the year. (To put this number in perspective, during the spring of 2007, crack spreads were above $20.)

Recently, crack spreads have improved. Yesterday, the spread closed at $12.44. Presuming oil prices continue to slide, the spread should continue to get better. Plus, October generally provides a seasonal bump as the temperatures cool.

Forecasts for Refiners

Brokerage analysts, however, continue to express pessimism in their profit projections for the major refiners. During the past 30 days, consensus earnings estimates have been cut on SUN, TSO and VLO. Notably, these negative revisions have been made on forecasts for both 2008 and 2009 earnings.

Many brokerage analysts were slow to factor in falling oil prices on Exploration & Production companies, so it is possible that they are also behind the curve in adjusting their 2009 forecasts. However, given the slowing economy and consumers' increased preference for fuel efficient cars, it is very difficult to predict what the refiners will earn next year.

Therefore, risk-adverse investors may want to wait for a clear trend in positive earnings estimate revisions to occur.

SUN and VLO are Zacks #3 Rank ("hold") stocks. TSO is a Zacks #4 Rank ("sell") stock. All three are classified in Oil Refining & Marketing (http://at.zacks.com/?id=4822).

Implications for Consumer Spending

Though I expect gasoline prices to continue to slide, I also believe that prices at the pump will remain expensive. After all, we thought gas was pricey a year ago when a gallon cost $2.81 a gallon.

Heating our homes will also be expensive as utilities pass along the higher costs and refiners charge more for heating oil. Not to mention that the Farmer's Almanac predicts this winter should be "numbing". Brrr.....

Higher heating costs will create another headwind for retailers. The back-to-school shopping season was weak and there is little reason not to expect a challenging holiday shopping season.

Apparel retailers and casual dining establishments could be particularly affected. Just within the past 30 days, brokerage analysts have cut forecasts on several companies dependant on discretionary consumer spending, including American Eagle Outfitters (NYSE: AEO | Quote | Chart | News | PowerRating) and Darden Restaurants (NYSE: DRI).

AEO is a Zacks #4 Rank stock and is classified in Retail-Apparel/Shoes (http://at.zacks.com/?id=4824). DRI is a Zacks #5 Rank ("strong sell") stock and is classified in Retail-Food & Restaurants (http://at.zacks.com/?id=4823).

The interactive Zacks Industry Rank List allows you to see all of the companies, and their Zacks Rank, within more than 200 industries. See the list at http://at.zacks.com/?id=3208.

About Zacks Industry Rank and the Zacks Rank

Zacks Industry Rank is calculated by averaging the Zacks Rank for all covered companies within a given industry. The Zacks Rank is assigned to approximately 4400 stocks and ranges from #1 ("Strong Buy") to #5 ("Strong Sell"). Both the Zacks Industry Rank and the Zacks Rank are quantitative indicators designed to cover periods of 1-3 months.

Since 1988, the Zacks Rank has proven that "Earnings estimate revisions are the most powerful force impacting stock prices." Since inception in 1988, #1 Rank stocks have generated an average annual return of +30%. During the 2000-2002 bear market, Zacks #1 Rank stocks gained +43.8%, while the S&P 500 tumbled -37.6%. Also note that the Zacks Rank system has just as many Strong Sell recommendations (Rank #5) as Strong Buy recommendations (Rank #1). Since 1988, Zacks Rank #5 stocks have underperformed the S&P 500 by 81% annually (+2% versus +11%). Thus, the Zacks Rank system allows investors to truly manage portfolio trading effectively.

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Zacks.com Charles Rotblut, CFA 312-265-9352 pr@zacks.com www.Zacks.com