Will Valero Energy Continue To Surprise?

| About: Valero Energy (VLO)

Summary

According to my calculation, we can expect a slightly better refining margin in the first quarter of 2016 compared to the fourth quarter of 2015.

Considering its compelling valuation metrics and its healthy earnings growth prospects, VLO's stock, in my opinion, is considerably undervalued.

The company generates strong cash flow and returns substantial capital to its shareholders by stock buybacks and increasing dividend payment.

The average target price of the top analysts is at $68, an upside of 14.3% from its April 15 close price, however, in my opinion, shares could go much higher.

Valero Energy (NYSE:VLO) is scheduled to report its first-quarter 2016 financial results on Tuesday, May 03, before market open. According to 18 analysts' average estimate, Valero is expected to post a profit of $0.80 a share, a 57% decline from its actual earnings for the same quarter a year ago. The highest estimate is for a profit of $1.69 a share while the lowest is for a profit of $0.44 a share. Revenue for the first quarter is expected to decrease 33.2% year over year to $14.25 billion, according to 6 analysts' average estimate. There were six down revisions during the last 30 days. Since Valero has shown earnings per share surprise in all its last nine quarters, as shown in the table below, there is a good chance that the company will beat estimates also in the first quarter.

Data: Yahoo Finance

Trying to estimate the refining margin for the first quarter of 2016, I have calculated the average price of Brent crude oil, WTI crude, gasoline, natural gas and heating oil in the fourth quarter of 2015 and the first quarter of 2016. The results are shown in the table below.

According to these findings, the decline in the price of crude oil, in the first quarter compared to the previous one is about 8% greater than the drop in the price of gasoline. However, it is about the same as the fall in the price of heating oil (heating oil is a part of the "distillate fuel oil" product family, which includes heating oil and diesel fuel).

As such, we can expect a slightly better refining margin in the first quarter compared to the fourth quarter of 2015. Also, the natural gas price is about 23% lower than in the previous quarter. That should contribute to the improvement in the refining margin in the current quarter. Refiners use natural gas as an energy source for the process; cheap natural gas helps to lower production cost.

According toHoward Weil's report from April 13, U.S. Gulf Coast's average crack spread in the first quarter was $9.38 per barrel, compared to $9.28 in the fourth quarter of 2015. U.S. Gulf Coast's throughput volume of 1.657 million barrels per day accounted for 58% of Valero's total throughput volumes of 2.854 million barrels per day in the fourth quarter. What's more, the Gulf Coast's crack spread has continued to increase since the beginning of March, as shown in the chart below. Valero reported a refining margin of $10.70 per barrel in the Gulf Coast in the fourth quarter much higher than the $9.28 reported by Howard Weil. This could be due to using cheaper sour crude by Valero. In any case, I do not expect a significant change in Valero's refining margins in the current quarter compared to the previous quarter.

Source: howardweil.com

The fact that most Valero's refineries are located in U.S. Gulf Coast carry many advantages, among them:

  • Access to low cost natural gas, North American and foreign crudes, deep skilled labor pool
  • Pipeline takeaway capacity additions have increased crude competition
  • Proximity to growing product export markets in Mexico and Latin America
  • Competitive refined products supplier to Eastern Canada and Northwest Europe
  • 13.4 weighted average regional Nelson Complexity Index
  • Flexibility to process wide range of crudes and feedstocks

Click to enlarge

Source: Howard Weil Energy Conference

Ethanol

Valero is the third largest U.S. ethanol producer, its ten ethanol plants have a total production capacity of 1.2 billion gallons per year. The ethanol segment reported adjusted operating income for the fourth quarter of 2015 of $37 million compared to $154 million in the fourth quarter of 2014. The $117 million decrease was mainly due to lower gross margin per gallon driven by a decline in ethanol prices versus relatively stable corn prices. Ethanol production volumes were 3.9 million gallons per day in the fourth quarter of 2015, an increase of 131,000 gallons per day versus the fourth quarter of 2014. The increase in production compared to the fourth quarter of 2014 was due to ongoing optimization and plant improvements.

The average price of ethanol declined in the first quarter of 2016 by 6.0% compared to the fourth quarter of 2015, as shown in the table below, while the average price of corn dropped by 4.8%. As such, we can expect a slightly worse ethanol margin in the first quarter compared to the fourth quarter of 2015.

Valuation

Since the beginning of the year, VLO's stock is down 15.9% while the S&P 500 Index has increased 1.8%, and the Nasdaq Composite Index has lost 1.4%. However, since the beginning of 2012, VLO's stock has gained 182.6%. In this period, the S&P 500 Index has increased 65.5%, and the Nasdaq Composite Index has risen 89.6%. Nevertheless, considering its compelling valuation and its healthy growth prospects, the recent drop in its price creates an excellent opportunity to buy the stock at an attractive price. According to TipRanks, the average target price of the top analysts is at $68, an upside of 14.3% from its April 15 close price, however, in my opinion, shares could go much higher.

VLO Daily Chart

Click to enlarge

VLO Weekly Chart

Click to enlarge

Charts: TradeStation Group, Inc.

Considering its compelling valuation metrics and its healthy earnings growth prospects, VLO's stock, in my opinion, is considerably undervalued. The trailing P/E is extremely low at 7.53, its forward P/E is also very low at 8.20, and its price-to-sales ratio is exceptionally low at 0.33. Furthermore, its price-to-free-cash-flow ratio is very low at 9.20, its Enterprise Value/EBITDA ratio is very low at 3.81, and the PEG ratio is also very low at 0.91.

On January 21, Valero announced a 20% increase in its quarterly common stock dividend from $0.50 per share to $0.60 per share. The annual dividend yield is pretty high at 4.03% and the payout ratio only 21.4%. The annual rate of dividend growth over the past three years was very high at 37.8%, over the past five years was also very high at 53.4%, and over the past ten years was high at 24.5%.

Click to enlarge

Ranking

According to Portfolio123's "ValueSheet" ranking system, VLO's stock is ranked first among all 63 Russell 1000 energy stocks.

Click to enlarge

The"ValueSheet" ranking system is quite complex, and it is taking into account many factors like; valuation ratios, growth rates, profitability ratios, financial strength, asset utilization, technical rank, industry rank, and industry leadership, as shown in Portfolio123's chart below.

Back-testing over sixteen years has proved that this ranking system is very useful. The reader can find the back-testing results of this ranking system in this article.

Summary

Valero is scheduled to report its first-quarter 2016 financial results on Tuesday, May 03, before market open. According to 18 analysts' average estimate, Valero is expected to post a profit of $0.80 a share, a 57% decline from its actual earnings for the same quarter a year ago. Since Valero has shown earnings per share surprise in all its last nine quarters, there is a good chance that the company will beat estimates also in the first quarter. According to my calculation, we can expect a slightly better refining margin in the first quarter compared to the fourth quarter of 2015. Considering its compelling valuation metrics and its healthy earnings growth prospects, VLO's stock, in my opinion, is considerably undervalued. The trailing P/E is extremely low at 7.53, and the Enterprise Value/EBITDA ratio is very low at 3.81. Moreover, the company generates strong cash flow and returns substantial capital to its shareholders by stock buybacks and increasing dividend payment. The average target price of the top analysts is at $68, an upside of 14.3% from its April 15 close price, however, in my opinion, shares could go much higher.

Disclosure: I am/we are long VLO.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.