Valero: Is Now the Time?

Includes: CVX, VLO, VSUNQ
by: Bret Jensen
Company Overview: Valero Energy Corporation (NYSE:VLO) operates as an independent petroleum refining and marketing company. The company operates through three segments: Refining, Retail, and Ethanol. The Refining segment engages in refining operations, wholesale marketing, product supply and distribution, and transportation operations. This segment produces conventional gasoline, distillates, jet fuel, asphalt, petrochemicals, lubricants, and other refined products, as well as a slate of premium products, including conventional blendstock for oxygenate blending, reformulated gasoline blendstock for oxygenate blending, gasoline meeting the specifications of the California Air Resources Board (CARB), CARB diesel fuel, low-sulfur and ultra-low-sulfur diesel fuel, and oxygenates.
Prognosis: The stock is down over 75% since its peak just before the start of the recession at the end of 2007. It has been battered by the falloff in demand for its products due to the economy, as well as drastic shrinking of its refining margins over the last couple of years.
Valuation: VLO is selling for a relatively high 16 times this year’s consensus earnings. However, it is trading at only 8 times next year’s consensus earnings of $2.19, in part driven the high variance of estimates. More importantly, it is selling at approximately 2 times peak earnings achieved in 2006. It has a piddling dividend yield of 1.1%. (Click to enlarge)
Crack SpreadsClick to enlarge
Catalysts: There are several factors that we believe should provide support for a higher stock price in the near and medium term:
1. Refining margins are improving significantly. Chevron (NYSE:CVX) announced this morning that their refining margins were up strongly, driving an improvement in their quarterly earnings projections.
2. Opportunity to purchase refining assets in Europe at distressed prices.
3. Eventual restoration of previous dividend level which would give VLO a dividend yield of 3.3% at current stock price.
4. The pickup of VeraSun’s (OTC:VSUNQ) refineries at rock bottom prices should prove to be a winner as ethanol crush spreads continue to improve.
5. Any political re-alignment from the midterm elections should result in a better legislative and regulatory environment for traditional energy concerns including refiners.
Recommendation(s): This stock is riskier than our average stock recommendation. It is very dependent on the U.S. economy continuing to grow (86% of revenues come from the United States) and refining margins staying stable or growing as part of that recovery. In our opinion, the stock is worth the risk as it is the largest refiner in North America, has the opportunity to pick up distressed assets, and should benefit as well from buying ethanol refineries at fire sale prices. We feel that it should be eventually valued at 3-4 times peak earnings or $26 - $36/share, up from current price of $17.79 for a substantial long term gain that makes this a speculative but lucrative play.
Disclosure: Long VLO