Valero's New Splitters For Bakken / Eagle Ford Condensates And Its Retail Spin-Off Mean More Value

Feb.27.13 | About: Valero Energy (VLO)

Valero Energy Corp. (NYSE:VLO) is the world's largest independent refiner with 16 refineries and 3 million bpd of throughput capacity. It has 6,800 branded marketing sites (1,900 in the US and Canada). It has 10 corn ethanol plants with a total capacity of 1.1 billion gallons per year (72,000 bpd). It has the Diamond Green Diesel JV under construction (10,000 bpd capacity). This creates diesel from waste cooking oil and animal fat. Plus it has a 50-megawatt wind farm.

Condensate prices have been falling as supplies of light oil have grown. US condensate sold for $26.47 per barrel less than Brent oil in Q4 2012. The average difference was only $6.70 in Q4 2010. With all of the new unconventional oil and gas fields, the amount of condensates available is skyrocketing. The Bakken and the Eagle Ford have a large amount of condensates. But the Utica, which is still in a very early developmental stage, has huge amounts of condensates. As development in the Utica ramps up, so will the amount of condensates available. I have left out many other fields, which probably also deserve mention, but the main point is that the US will soon have a condensate glut, if it does not already have one. The refinery companies that take best advantage of this will likely be the most successful in the future.

Valero and other refiners such as Marathon (NYSE:MPC) are building new splitters and upgrading current refineries to process condensates. Valero announced in April 2012 plans to expand capacity for condensates and NGLs at its 142,000 bpd refinery in Corpus Christi, Texas, and its 93,000 bpd plant in Three Rivers, Texas. Permitting was the near term holdup. Valero says that increasing feedstock processing capacity involves a relatively small amount of work compared to building new crude processing units.

Splitters can convert condensates to petroleum products for as much as $1-$2 less per barrel than a conventional refinery. In essence, this will mean $1-$2 of greater profit from the refining process. This is not even taking into account the huge difference in price ($26.47 per barrel in Q4 2012) that now exists between Brent (light sweet crude) and condensates. Valero intends to take advantage of this as part of its longer term strategy. This should add value for shareholders, especially as more Atlantic Basin refineries are expected to close in the near future. Further, many South American and Central American refineries have low utilization rates. Many of those refineries break down a lot. This too will provide more opportunity for export of refined petroleum products to those countries, especially as the many emerging market economies there grow quickly.

The chart below shows that the growth in petroleum demand is in the emerging market countries.

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The US has laws against the export of crude. However, it does not outlaw the export of refined petroleum products. As long as this situation persists, that puts VLO and other US refiners on a firm growth curve that should last many years. Investors can profit from this. Not surprisingly the US is now a net exporter of petroleum products (refined products not including crude oil).

The chart below shows the ramp up in US crude oil production from the development of new US shale fields. The chart doesn't show condensate and NGLs production increases, but those are also seeing huge production growth. These should provide good, cheaper feedstock for the US refineries.

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The crack spread is also staying high enough for good profits. With the increasing demand from emerging market companies, the crack spread is expected to stay strong. Partly due to the slow world economic environment, many of the new foreign refinery builds or capacity expansions have been delayed. This should help demand for US refiners. A chart of the last year's WTI Cushing Crude Crack spread is below.

Investors should also be able to profit from VLO's spin-off of its retail arm. VLO tends to be viewed as only a refinery company. If its retail arm does well, that is discounted. If it does poorly, it is seen as a negative drag on the "refinery" company. The spin-off should improve that situation. The spin-off is scheduled to occur in Q2 2013. 80% of the shares of the new retail arm entity, Corner Stores (NYSE:CST), will be distributed to VLO's shareholders on a one for one basis. VLO will retain 20% of the shares. It is important to note that VLO is only auctioning off its 1,800 Corner Stores retail outlets. The company will still operate about 5,000 retail outlets. The spin-off is expected to unlock about $3.5B in value. The deal is expected to close by the end of July 2013. If it is successful, investors could see further spin-offs of retail assets. VLO is a long term buy.

The two year chart of VLO provides some technical direction for this trade.

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The slow stochastic sub chart shows that VLO is neither overbought nor oversold. The main chart shows that VLO has been in a strong uptrend since June of 2012 (and yes, I did recommend it last year). In fact, the trend if anything appears to be too strong. VLO's price line is far above its 50-day SMA. VLO's 50-day SMA is far above its 200-day SMA. Technically you should avoid buying at this time.

Since the overall market is itself overbought currently, many are expecting it to pull back by 7% to 10% in the immediate future. The EU credit crisis is back in the news again. And if anything, it seems worse than before. There is still the US sequester that may become active on March 1, 2013. The US economy has already slowed considerably from its +3.1% GDP growth rate in Q3 2012 to a -0.1% GDP growth rate in Q4 2012. This last will probably be revised upward in the next revision due to the low US trade deficit number in December 2012. Still there is dramatic slowing, and a US recession is very much a possibility for 2013.

With the above in mind, it is probably a good idea to wait for the pullback. Then you can begin to average in. With the threat of a recession in the US in 2013, you will want to average in over the course of the entire year (or more). In this way you should get a good average entry price for a stock that appears to be a secular grower for many years into the future. The already low PE of 12.12 and FPE of 7.84 make you want to buy right away, but it will probably be better to wait. VLO also pays a 1.70% dividend, which may increase with the spin off (a second dividend from CST and more eventually from VLO). The average analyst recommendation for VLO is 2.2 (a buy).

NOTE: Some of the above fundamental financial data is from Yahoo Finance.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.