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By Carla Pasternak

Valero L.P. (VLI) was formed in 2001, when giant oil refiner Valero Energy (NYSE:VLO) spun off its pipelines, terminals, and storage tanks. The master limited partnership became largely independent of the parent company and more than doubled its asset base with the 2005 acquisition of Kaneb's pipeline and services companies. Valero now boasts 9,300 miles of pipeline that carry crude oil and petroleum products from Texas to Minnesota. These government-regulated pipelines give the company a secure revenue base. The firm also operates terminals and crude oil storage tanks that generate stable fee-based revenue, partly secured by VLO's refining operations. About 48% of revenue comes from the regulated pipelines and 52% from the fee-based terminals and storage business.

Dividend: Valero L.P. has increased its quarterly dividend an average +9% a year since initiating dividends in 2001. Its latest quarterly dividend of $0.915 translates to $3.66 per share annually, giving VLI a generous 5.6% yield at current share prices. The company pays out 87% of its distributable cash flow in dividends, giving it enough room to boost its dividends further in the coming years. Management has committed to hiking the distribution another +7% this year. Valero doesn't offer a dividend reinvestment plan.

Growth Drivers: Over the past five years since its inception, Valero has invested $3.6 billion in acquisitions, including the $2.9 billion Kaneb purchase. This acquisition provided Valero with a large inventory of expansion projects that should drive growth and increase distributions over the next few years. The 2007 planned expansion budget of $185 million is the largest in the company's history and will increase the firm's storage and distribution capacity in its fee-based terminal business. Tariff increases in line with inflation will also contribute to growth. Despite the company's rapid growth, it maintains a strong balance sheet with a debt to total capitalization figure of just 42%.

Outlook: After five years of relatively slow growth of about +4% per year, the company is expected to deliver double-digit earnings growth by 2008. Internal expansion projects should keep Valero L.P. on the fast track, with an estimated +7% annual growth rate over the next five years.

Risks include reduced demand for petroleum products, higher-than-anticipated maintenance costs on acquired assets, and downtime at Valero's refineries due to upgrades.

Action To Take: With its geographically diverse assets, stable revenue streams, and sound balance sheet, we consider VLI a fairly low-risk investment with solid dividend growth potential.

Please note that Valero L.P. recently announced plans to change its name to NuStar Energy L.P. The name change will be completed on April 2, 2007, and at that point in time the firm's ticker symbol will change from "VLI" to "NS."

VLI 1-yr chart
VLI

Source: The Long Case for Valero L.P.