Valero Energy (VLO) has gained 44% so far this year and the majority of this performance was earned over the last eight weeks as the entire Oil & Gas Refining & Marketing sector surged. Shares of Valero Energy were trading at $33.73 on October 8, 2013 and are now quoting at $46.77: A massive increase of 39% in a matter of two month. Valero Energy trades close to its 52-week High at $47.22 (according to Bloomberg) and a break could add to already strong momentum.
If compared to other major refinery plays, Valero Energy has the best trailing twelve month performance. Valero Energy has returned an outstanding 59% over the last 52 weeks. Marathon Petroleum (MPC) gained 47%, Tesoro (TSO) 41%, Phillips 66 (PSX) 37% and Western Refining (WNR) 36%.
Industry profiting from shale exploration boom
In a related article I have summarized my thesis about the US refinery business which led me to a positive industry outlook. The relevant passage read:
Declining refinery margins were a trend that affected a variety of refinery businesses of major oil companies and it is of course difficult to forecast refinery margins as they are subject to market prices and macroeconomic conditions. However, I believe it is fair to assume that Phillips 66 as well as other refinery players will be able to return the segment to long-term profitability as US energy production booms. The surge in domestic oil- and gas production certainly necessitates massive investments in transportation, storage and refinery capacity.
Hydraulic fracturing and shale exploration are the major themes that, in my opinion, will lead to strong demand for transportation- and refinery capacity in the coming years. Almost any company currently working in the US oil- and gas sector is likely to do well over the next couple of years. The boom in US onshore shale exploration will be a game-changer for US energy independence and offer companies significant export opportunities. Large independent refineries such as Valero Energy are prime beneficiaries of booming domestic oil- and gas production. The following graph depicts that US shale crude production is expected to increase significantly until 2020.
Production increases require transportation-, storage- and refinery capacity in order to funnel energy commodities through the value chain and bring them to market. Consequently, refinery capacity is expected to increase over the next couple of years in order to accommodate materially higher expected throughput volume.
Valero Energy creatively generates value for shareholders. It has spun off 80% of its retail business CST Brands (CST) on May 1, 2013. Valero Energy Partners LP also filed a registration statement with the SEC in September outlining its intention to create a logistics MLP in order to unlock shareholder value and allow the market to value its logistics unit more appropriately. A publicly traded MLP could fetch a significantly higher valuation and regular distribution income as well as share repurchases could provide further catalysts for higher equity valuations.
The entire US refinery & marketing sector is relatively cheap. Shares of refineries have taken a hit during the second and third quarter of 2013 as worries about declining refinery margins dominated the headlines. While I believe those worries are overblown, they also offer investors the chance to pick up some first-class refinery plays at depressed multiples. Even though stocks have recovered quite a bit since October, overall valuations are still low enough to justify either an investment or additions to existing portfolio positions.
Valero Energy remains one of my top refinery picks in the sector because the company creates a variety of catalysts and it trades at one of the lowest earnings multiples in the large-cap refinery segment. The company achieves a forward multiple of 10.17 which is equivalent to a massive 9.8% earnings yield. Phillips 66, which is the refinery business spun off from ConocoPhillips (COP), is another deeply discounted refinery player trading at a multiple of 10.82x forward earnings. Phillips 66 also makes a great long-term investment for investors who want energy exposure and profit from both capital appreciation and income (Phillips 66 long thesis here).
As usual, the table below summarizes Valero Energy's key metrics like market cap, P/E, PEG and D/P ratio and compares them to the peer group mentioned above.
Valero Energy is an independent refinery play committed to proactively create value for shareholders. The spin-off of its retail unit was the right move for shareholders and is a classic maneuver to unlock value. Over time, the spin-off should receive a higher valuation than if the retail unit stayed as a part of a more complex and less transparent Valero Energy structure. A possible MLP registration will add to higher transparency and likely a higher stock market valuation. Logistics MLPs trade at 10-15x EBITDA and give investors significant valuation upside. In addition, an income-focused MLP will attract new buyer segments which also should support prices. Long-term BUY on multiple catalysts, possibly higher earnings valuation for the MLP and attractive positioning in a booming US energy market.