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Summary

  • The growing demand of liquids in the U.S will support the growth for Valero over the next few quarters.
  • Ethanol business has been able to report strong growth numbers due to a decrease in corn prices and favorable ethanol prices.
  • EIA sees further growth in liquids demand and HGL, which will allow the refiners to continue growth over the next few quarters.

Valero Energy Corporation (NYSE:VLO) is an independent petroleum refining and marketing company which produces conventional gasoline distillates as well as other premium petroleum products. The company operates its petroleum refineries in U.S., Canada, U.K. and Aruba along with 10 ethanol plants in the central plains region of the U.S, which proved to be major growth driver for the company. The stock performance has been impressive and the stock has gained over 50% during the last twelve months.

We believe Valero Energy is well-positioned to take advantage from the increasing crude oil demand situation in the U.S., which rose by 400,000 bbl/d in the last year. Also, the increased propane demand is also likely to result in considerable gains for the company over the next few quarters.

The recent volatility in the stock price was due to the Commerce Department's decision reversal, stabilizing global petroleum demand and Canadian shale development. Initially, the stock fell sharply, following the trend in the whole sector, due to a regulatory decision by the Commerce Department regarding condensate exports. The decision allowed two E&P companies: Pioneer Natural Resources (NYSE:PXD) and Enterprise Products Partners (NYSE:EPD), to export the condensate directly in the global market. However, the decision was taken back for reconsideration and was put on "hold" for final proceedings.

Business Model

Valero Energy is the largest refiner in the U.S. with a total throughput capacity of around 1.8 million barrels per day [bpd. The company reports its business operations under two segments: Refining and Ethanol. The refining segment includes refining operations, wholesale marketing, product supply and distribution, and transportation operations in the U.S., Canada, U.K., Aruba and Ireland. On the other hand, ethanol segment primarily includes sales of internally produced ethanol and distiller grains. Further, the company has mitigated risk by spinning off its retail business by creating an independent entity named CST Brands (NYSE:CST) in the last year. Valero also secured long term retail sale agreement with CST brands, which further reduced its risk and secures revenue stream in the future.

Valero Energy: Refined Growth Story

The demand for liquids has grown at an exceptional rate in the U.S. during the last year - the consumption of liquid fuels went up by around 400,000 bbl/d (2.1%) during the period. Consumption of hydrocarbon gas liquids [HGLs] registered the largest gain in 2013, increasing by around 150,000 bbl/d compared to the previous year. Further, this increase in demand and consumption of liquid fuels created significant opportunities for oil refiners to record impressive gains. However, Valero Energy reported a minor operating revenue shortfall in the last year, which is mainly due to lower refining margins in company's domestic as well as international markets.

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Source: SEC Filings

The decrease in refining margins is due to lower gasoline margins, lower discounts on light sweet crude oil, and higher costs of bio-fuel credits. The company also reported decreased Retail segment revenues as a result of spinning-off 80% of CST as an independent public company. Despite the decreased margins in the last year, the company reported increased net profit of $2.7 billion with per share earnings of $4.97, which is up 32% compared to 2012.

However, these decreased operating margins are offset by the substantial gains in the Ethanol segment, which reported increase of around 1,140% in the last year. The ethanol segment reported income of $538 million compared to a loss of $47 million in 2012. This increase is mainly due to higher gross margin per gallon and higher production volumes of ethanol. Further, lower corn prices and higher ethanol prices contributed to improved gross margin.

Source: SEC Filings

Valero Energy reported impressive gains in the second quarter, with an operating income of around $1.1 billion compared to $805 million in the second quarter last year. This increase is mainly due to higher refining throughput volumes and wider discounts relative to Brent crude oil for sour and certain North American light crude oils. Further, Ethanol operating income also reported impressive gain in the second quarter, showing around 97% increase compared to the same period last year. The company also increased its quarterly cash dividend from $0.25 per share to $0.275, representing a solid dividend yield of around 2.06%.

Conclusion

Valero Energy is well positioned to benefit from the growing demand in the U.S. The company has strong earnings growth prospects and is generating strong operating cash flows. The export of refined products is also a growth opportunity for Valero Energy in the long-run, which is further complemented by company's assets on the Gulf Coast. Moreover, the 10% dividend yield of the company is also very lucrative for the income investors. We believe Valero Energy is a solid long-term pick for growth as well as income investors.

Additional Disclosure: This article is for educational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.

Source: Is Valero Energy A Good Investment?