- Valero fell 10% last week due to a change in the restrictions on certain oil exports by two US based companies.
- While the initial drop in price is understandable, the large extent of the fall in price is unwarranted.
- Valero has strong financial metrics, showing it as a good investment for the value investor.
- The recent fall therefore represents a strong entry point to purchase shares at a discount.
Valero (NYSE:VLO) is a buy because of the recent dip in price; strong financial metrics; and broader, external macro-economic factors.
On Wednesday, June 25th, we saw the initial dip in Valero and it finished the week down overall. However, this is really to the benefit of future investors, as it has become difficult to find discounted stocks in the oil and related industries due to global factors. As a result, Valero is now uniquely positioned to provide the potential investor with a strong value play.
Here are several reasons to consider adding Valero to your portfolio:
1. Strong financial multiples from the value investor perspective.
2. Recent dip which provides a strong entry point and allows the investor to realize additional value.
3. Profit margin squeeze will be less than currently anticipated.
EV/EBITDA: Valero has a low EBITDA Multiple when compared against its peers.
Here you can see that Valero is currently at 4.85 with the next lowest being Marathon Petroleum (NYSE:MPC) and Alon USA Energy (NYSE:ALJ) at roughly 6.5. Valero is therefore severely undervalued with respect to EV/EBITDA when compared against its peer group.
P/E Ratio: The P/E Ratio for Valero also seems to indicate that it is undervalued with respect to its peer group.
Naturally, we will exclude ALJ from the comparison as the negative earnings per share has rendered the P/E useless in this regard. Nevertheless, with respect to Valero, we can see that at 9.8 this is still lower than the nearest comparable which is Phillips 66 (NYSE:PSX) at 12.75. Once again, with respect to Valero, the P/E shows the stock as undervalued.
Price-To-Book: The P/B for VLO also seems to show it as a favorable investment opportunity.
Here we have Alon USA Energy coming in just above Valero, and with Valero coming out ahead of its peer group with a P/B of 1.4. The next closest is PSX at a P/B of roughly 2.2.
Based on the P/B, the P/E and the EV/EBITDA, we can easily see that Valero is rather poorly valued with respect to its peer group. The stock should certainly be higher and probably would be if it weren't for the current price dip.
The reason for the dip in price for Valero and its peers is simple: there was a recent decision by the administration to consider condensate or ultralight oil as an available export for two companies. Pioneer Natural Resources (NYSE:PXD) and Enterprise Products Partners (NYSE:EPD) can now export this portion of oil straight out of the country without running it first through United States based refineries. Now that this oil will be chasing the highest dollar amount within the global community as opposed to the United States, it will demand a higher price than it currently has (due to the increase in scope with respect to demand).
It is believed by the investing community that this change in the legal restriction with respect to the export of the condensate oil will lead to lower profit margins for the refining community and companies such as Valero. The question is whether or not this perspective is warranted. Naturally, if profit margins go down for Valero, then this is a legitimate reason for the stock price to go down. However, if it is not, then the current dip in price presents a strong entry point for the value investor to buy some discounted shares.
Profit Margin and Product Pricing:
Building on what was previously stated; we can see that the perspective of a decrease in profit margin for Valero is not entirely unfounded. This being said, it is rather unclear how the investing community believes that companies within the refining community will not raise revenue through the pricing of their final product as the cost of producing their product goes up.
Valero and its peer group are in a unique position, in that they provide a product that nobody can simply walk away from. Consequently, as prices go up for their inputs, the price should go up across the board and at the gas pump for the general consumer. The only downward pressure that can exist for the price of their final product would exist in the form of imports. Fortunately for the investing community (but unfortunately for the general consumer), the transportation costs help keep this at bay.
Does it make sense that the price of Valero fell during last week? Sure it does. The administration's approval of the exports for Pioneer Natural Resources and Enterprise Product Partners marks the first time in nearly 40 years that this will be allowed. However, the price fell nearly $6 per share from just around $58 and finished the week in the mid-$51 range. For the strong metrics that Valero has to offer against its peers, and for the limited damage that the exports will do to the profit margin, it is difficult to believe that the stock is currently properly priced.
I therefore believe Valero is a buy at current price levels.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.