Valero: More Upside Than Downside - Barron's

Oil refiner Valero Energy (VLO) doesn't extract its own oil. As the price of oil has risen, its margins have been pummeled, and so have its shares, down 30% YTD to $48. It recently projected Q1 EPS of $0.10-0.35, way below Street forecasts of $0.91.

Barron's says that despite the gloom, crack spreads (the difference between the price of gas and crude) have bottomed and are widening; after going negative a few weeks ago, they're back to $7.43/barrel. Analysts say that a $10 spread is sustainable.

Citi analysts say Valero's downside is limited to about $43.80 -- and that assumes worst-case earnings and its historical lowest P/E multiple. It also trades at a sizeable discount to the replacement value of its refineries; CEO Bill Klesse has said he wants to sell four of its 17 refineries, and there are rumors Petrobras (PBR) is stalking its Aruba refinery. With the proceeds, Valero plans to pay down debt and repurchase shares. Valero's refineries are also equipped to refine the lowest quality crudes, which few others can do.

Analyst Paul Sankey of Deutsche Bank think shares have more than 60% upside.

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Here's Valero's most recent earnings call transcript. Of interest, CEO Bill Klesse conceded (on Jan. 29) that, given the choice, the company would like to produce summer-grade gasoline early (due to its higher crack spreads) and hold onto it until the summer driving season. Something for investors to look forward to?

Comments

[fzendell:]

The article states "As the price of oil has risen, its margins have been pummeled". I believe a clear explanation of how the price of oil affects VALERO'S margins. Isn't the cost of the refining process added onto the cost of the crude?

2008 Apr 14 08:27 AM

[Eli Hoffmann:]

Fzendell,

Barron's doesn't go into the details, but I think the basic premise is that low-cost base materials leave more leeway for refiners to tack on healthy refining charges, but as the cost of the raw materials rises, they are forced to eat into their margins or risk pricing the refined product out of the reach of may consumers.

2008 Apr 14 08:29 AM

[redbaron:]

The concept, as I understand it, is that 'crack spreads' (margins from refinning crude into gasoline) historically go up in the summer, and that has been charted elsewhere within these blogs. VLO's stock price is highly correllated to cracks spreads, and often moves up during the 'summer driving season'. I own the stock.
JK

2008 Apr 14 08:35 AM

[jyoung01:]

HTE is a better play.... They are an E&P with a killer dividend

2008 Apr 14 08:47 AM

[fxtrader07:]

i believe crack spreads will be far higher going forward, regardless of the price of oil. demand for refined products is on the rise - everywhere, including the middle east. alas, those countires import a vast quantity of refined products as they themselves are lacking sufficient capacity. the same is true for the u.s. refining capacities are way too low to cope with demand despite several projects to add capacity and to switch from sweet to sour-crude processing.
Crude imho will meander between 80 and 120$/barrel for the next couple of years giving refiners ample opportunity to increase their margins. gasoline demand, by and large, is very inelastic as is demand for heating oil. low crack spreads are un´sustainable for more than a few weeks as refiners will simply curb production or ship more refined goods abroad. imho most refiners are a steal at current prices and will appreciate considerably over the next 2-3 years

2008 Apr 14 09:43 AM

[Diegojames:]

HOPEFULLY CRACKSPREAD WILL MAKE VLO STOCK SURGE - I HAVE BEEN HURTING,,,,GOOD NEWS THAT THERE IS A FLOOR AND SOME ONE WANTS TO BUY REFINERIES..BUT WE NEED MORE REFINING TO KEEP PUMP PRICES DOWN??? OK I WILL DRIVE LESS ....

2008 Apr 14 07:26 PM

[WayneS:]

Pump prices of gasoline need to go up to supply a more reasonable refiners margin and to force a reduction of extreme waste of a limited resource. Eliminating this waste will also reduce green house gases release.

2008 May 13 12:22 PM

[simplesimon:]

I can't always resist the temptation to remark on the latest world view fad, namely the alarm over greenhosue gases. Yes, we need to curtail them...but as we do, China and India, et.al, will have no regard, thus the net effect will be less than zero. And there is one other fact missing from the 'edification portoflio' of the vast majority of folks. Namely that ice ages occure like the continual ringing of a phone, and only the burning of fossil fuels has disrupted the "natural flow". This line of think is way down there with Carl Sagan's "We are star stuff". I know this pushes all the hot buttons , but here we go: There has been one ice age, and one ice age only. This happened after the collapse of the vapor shell that was originally part of the greenhouse design before the 'Noahic Flood' ( caused by the meteor strike that created Hudson Bay, for one thing ). The continents have been draining eever since, with ever increasing desertification world wide. The flora and fauna that teemed pole to pole before were washed en masse into basins ( vis the Oklahoma Basin where oil fields were tapped for three generations - and into the Gulf of Mexico, and recently off Brazil - the next great untapped oil reserve ).


On May 13 12:22 PM wayneS wrote:

> Pump prices of gasoline need to go up to supply a more reasonable
> refiners margin and to force a reduction of extreme waste of a limited
> resource. Eliminating this waste will also reduce green house gases
> release.

2008 May 14 09:22 AM