The refining and marketing industry looks strong through 2020, according to Morgan Stanley. The firm upgraded the sector and named a new top pick.

The Analyst

Morgan Stanley’s Benny Wong upgraded his R&M industry view from In-Line to Attractive.

Won upgraded Valero Energy Corporation VLO 4.83% from Equal-Weight to Overweight and raised the price target from $110 to $140.

The Thesis

The R&M sector stands to gain from underinvested supply that will struggle to keep pace with growing global demand, Wong said in a Wednesday note. (See the analyst’s track record here.)

A number of factors have caused the industry to restrain investment in refining capacity, including long-term demand uncertainty and the hype surrounding electric vehicles, Wong said. Limited supply growth relative to robust demand — especially in emerging markets — provide global refiners with a strong tailwind, he said.

“In the simplest terms, we believe the world needs three refineries every year to match demand growth, and it will fall short by one refinery each year through 2020,” the analyst said.

Morgan Stanley expects refining margins to expand by 30 percent through 2020.

U.S. refiners in particular will benefit from regional tailwinds, Wong said: they sit on “abundantly cheap” natural gas and crude oil which, along with regulation rollbacks by the Trump administration, will allow them to gain market share.

In line with this view, Wong upgraded Valero, citing the company’s high-quality exposure to the current refining upcycle, low cost structure and growing exports.

The upgrade makes Valero one of Morgan Stanley’s top R&M picks along with Marathon Petroleum Corp MPC 4.43%.

Price Action

Valero Energy shares were up 4.7 percent at $120.36 at the time of publication Thursday morning.

Other refinery stocks also traded higher:

  • Marathon was up 4.3 percent.
  • PBF Energy IncPBF 4.85% was up 4.9 percent.
  • HollyFrontier CorpHFC 4.48% was up. 4.45 percent.