Valero's Profit Margins Will Expand Even If Gas Prices Fall

Valero Energy (VLO) operates 16 oil refineries across North America with a combined throughput capacity of over 3 million barrels per day [BPD]. It sells refined products such as gasoline, heating oil, diesel fuel, and jet fuel through 5,800 wholesale and retail outlets under the Valero, Diamond Shamrock, Shamrock, Ultramar, and Beacon banners. The refining segment was responsible for 91% of 2007 net sales and 97% of operating income.

Over half of its refining throughput capacity is in the Gulf Coast region (Texas and Aruba). The rest is in the Northeast (Quebec, Delaware, and New Jersey), the Mid-Continent (Tennessee,Texas, and Oklahoma), and the West Coast (California). About half of VLO’s feedstock throughput is sour and acidic-sweet crude oil, a quarter is sweet crude oil, and the remainder consists of residual oils, blend-stocks, and other feedstocks. Sour and acidic-sweet crude are cheaper than sweet crude because they are more difficult to process. Almost half of VLO’s refined yield consists of various forms of gasoline, a third are distillates, and the remainder are petrochemicals, asphalt, lubricants, gas oils, No. 6 fuel oil, and petroleum coke.

Retail operations across the U.S. and Canada accounted for the balance of 2007 net sales and operating income. This segment sells fuel, heating oil, and convenience store merchandise. In 2007,VLO operated 953 locations in the U.S. that sold 113,500 BPD of refined products under the Valero and Diamond Shamrock banners. It operated 920 Ultramar sites in Canada that sold 77,000 BPD of refined products. High oil prices have helped energy companies book record profits. Refiners, however, have seen profits plummet because the difference in price between a barrel of refined product and a barrel of crude oil—the so-called crack spread—narrowed.

Thanks to higher selling prices,VLO reported a 49% year-over-year increase in net revenues in Q1. However, due to the surge in oil prices, the company’s throughput margin shrank 30% to $8.48 per barrel.

The operating profit margin was further impacted by higher energy costs. Net income from continuing operations plunged 76% year-over-year to $261 million or 48 cents per share. Similarly, Q2 net revenues increased 51% year-over-year and the throughput margin fell 40% from the year earlier period to $10.82 per barrel. Net income from continuing operations dropped 64% to $734 million or $1.37 per share. Although margins were down year-over-year, they improved considerably over Q1 levels. While oil prices remain high and volatile, we are encouraged that they have been easing in recent weeks.

VLO’s profit margins will expand even if gasoline prices fall, as long as they hold up better than oil prices. We are optimistic this will happen because gasoline did not rise as much as oil to begin with. Still, even if its profit margins expand, falling demand for gasoline could reduce throughput volumes.

Gulf Coast prices for conventional gasoline, No. 2 fuel oil, and low-sulfur diesel climbed 28%, 30%, and 29%, respectively from Q1 to Q2. These gains slightly outpaced the price rise in West Texas Intermediate crude oil during the same period. Management also noted that sour crude discounts have become more favorable. As for the future, the Energy Information Administration is predicting higher crack spreads through at least 2009.

Comments

[MistaWhite:]

Do you have any thoughts on whether TSO or VLO is a better buy? Did you look at that as well?

2008 Aug 07 07:31 AM

[John-Galt:]

The main difference I can see is that VLO has a better ability to use lower-grade (sour) crudes as input stock. There may be other issues as well.

2008 Aug 07 09:27 AM

[ole fella:]

VLO dropped just below 30 about a month ago for a short while interday. Probably will not do that again. Entry in the low 32 range should be very safe. Also very tradeable if you have no nerves.

2008 Aug 07 12:43 PM

[rhj123:]

The much smaller refiner, FTO, is now priced about $18, very low. Could be a good entry point for this small, stable refiner with a good history. They handle sour crude and have done so for years with nice profits, etc.

2008 Aug 07 01:20 PM

[Urbane Gori...:]

The ability to refine sour crude is it's biggest asset (IMHO) ... Most countries that are able to boost output (Saudi Arabia for example) are only pushing sour. Other refiners will have to begin to retrofit their operations to utilize this lower grade (most present US refiners are set for sweet crude... )...

Another play on this is Graham Corp (GHM) as they function as a sour crude retrofit company.. It is getting a little toppy, but keeps surprising on pullbacks.

jegan ;-)

2008 Aug 07 02:27 PM

[Urbane Gori...:]

Forgot to add..

"schnickelfritz" .. It seems to be bouncing along a bottom at the present. If oil keeps going lower, then it's probably a buy here... But use a tight stop in case we get some weather in the Gulf....

jegan ;-)

2008 Aug 07 02:30 PM