Originally published on April 28, 2014.
Currently trading in the mid-$50 range, Valero Energy Corporation (NYSE:VLO) represents an excellent opportunity for investors.
Whether the investor is aiming to add to the diversity of their energy portfolio or create a new position in this industry, 2014 Q2 is the right time to jump into this stock. Based out of San Antonio Texas, Valero is the leading refiner with an output of 3.1 million barrels per day (BPD). In 2013, Valero rid itself of its retail obligations by creating the spin-off CST Brands (NYSE:CST). Going forward, VLO will operate in two segments: refining and ethanol. This refined focus allows the company to reach its potential in its desired segments and maximizes its value to shareholders. Thorough analysis of the company's financial statements has been conducted to yield the projections that see VLO stock reaching as high as $90.53 in 2014.
Primarily operating out of the Western Hemisphere, predominately the United States, VLO has 16 petroleum refineries and 10 ethanol plants (see map, above). The company's production acts on a wholesale basis, as it markets banded and unbranded refined products in the U.S., Canada, the Caribbean, the U.K., and Ireland. While subject to standard refining risk factors, VLO gains a competitive advantage through obtaining its feedstock at discounted prices from sources other than the standard market price.
VLO has undergone substantial gross over the past five years and is a highly ranked Fortune 500 company. While the company has undergone some negative growth, in large, its positive growth is more impressive. Since 2009, the revenue has more than doubled and net income turned positive. Cash flow has soared to an all-time high which has catapulted the price forward. Figure 2 conveys information relating to the average growth rates in key areas for the past five years.
With the removal of retail operations for the 2014, we could see the overall revenue falter, but the segmental revenues are projected to increase.
In analyzing the stock price, we start by observing quarterly revenue numbers over a ten-year period. Over this period, we have seen an average growth of 18.72% in Q1, 16.71% in Q2, 16.48% in Q3, and 15.25% in Q4. Figure 3 displays the historic revenues and their growth from year to year on a quarterly basis (Example: [Q1 Growth 2013= (Q1 Revenue 2013-Q1 Revenue 2012)/Q1 Revenue 2012]).
Amidst the worst global financial crisis and its ensuing recovery, VLO has experienced a minimal amount of negative quarters. To determine whether or not the industry was experiencing a good, average, average or bad quarter in comparison to the preceding year, we look to the world production of oil on a BPD basis for each quarter. Figure 4 introduces us to these growth numbers. Growth numbers are calculated by the following formula:
Q1 Growth 2013= (Q1 Production 2013-Q1 Production 2012)/Q1 Production 2012
Because revenue and production are analyzed through utilizing the same formula to project growth, we can then apply a label to the quarters in Figure 3 as Good, Average, or Bad, based off the numbers generated in Figure 4. Negative quarters in Figure 4 are determined to be Bad, 0-1.40% growth are determined Average, and 1.41%+ are determined Good. Once these determinations are applied to Figure 3 quarters in the form of paralleling colors (as seen above in Figures 3 and 4), we can combine the total growth of all Good, Bad, and Average quarters to then divide them by the total number of quarters for each as displayed on the right side of Figure 3. The result of these two tables and calculations yield our overall growth results in the different industry climates to show us what VLO's growth may look like. As we can see, in the best case scenario, VLO could experience growth as high as 30.38%.
With the information previously extracted, we take the numbers and integrate them with financial statements. Once this is completed, we can project the future financial scenarios under three different industry conditions. Figure 5 displays the results of this integration. (Note: "Current" numbers are adjusted from the stated 2013 numbers to reflect the suspension of retail operations that occurred with the separation of retail operations into a new entity, CST.)
The only significant reduction we can conclude from this table is that which stems from a reduction in earnings per share, given a bad climate; however, we do see growth in cash flow per share in the same climate.
All of the above stated information leads us to Figure 6, where we can see the projected stock prices in nine different scenarios (scenarios 10, 11, and 12 at the bottom of the table are averages of the nine in their respective columns).
As we can see, there is only one scenario that projects the stock price to come out to a level where it trades at a level that is lower than its current market price. While the best-case scenario is derived from the cash flow generated by VLO, it is likely that the market price will end in some place between these two limits. Since the numbers in Figure 5 were already adjusted to reflect VLO's future without the retail segment, this valuation of their predictable stock prices is a fair reflection of their current operations.
Before deciding to build a position in VLO, we must note that the petroleum industry is subject to volatile swings. Environmental factors, geopolitical conflict, and large swings in crude oil prices could negatively impact VLO and its competitors. With that said, VLO does reflect the financial standing of a solid company in the industry. From an energy portfolio perspective, it is fair to say that VLO's performance will either be equal to or better than their competitors'. Figure 7 reflects their historic financial ratios. The consistency and growth within the company appears to be sustainable and they have done a sufficient job of reducing their overall debt in relation to other factors.
My final recommendation for this stock to the investor is to buy and hold. On top of the massive growth in VLO's future, the shareholder can expect a $0.025/share dividend growth semiannually. Dividends are paid on a quarterly basis and in 2013 the dividend payout totaled $0.85. Valero Energy Corporation is a strong company in a cornerstone industry that exercises a commitment to excellence. With its transformation since its incorporation in 1981, expect Valero to evolve, as it has historically, in order to meet the demands of the market.
-Information in this article is derived from the 2013 Valero Energy Corporation 10-K and my personal excel files. The first image in this article is the direct property of Valero Energy Corporation and can be found on their company website.
Disclosure: Author does not have any holdings in VLO.