Refined Preview of Valero Energy's Q3 Earnings Call
Cory is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Valero Energy’s ) third quarter earnings call is just days away. The company appears undervalued, but so does most of the oil and gas industry. Instead of waiting for mindless, computer generated earnings analysis to distort our perceptions, lets define some criteria for success or failure ahead of the call.
Something’s Happening Here
Average analyst earnings estimates for Valero have risen 21% over the past three months from $1.43 to $1.73 per share. Over the same time period the refiner’s share price has risen only 3.6% from $27.50 to $28.49. I will be very surprised if the stock doesn’t make a big move after reporting third quarter earnings.
Separating Retail Business From Core Refinery Operations
Valero Energy is America’s largest independent refiner of petroleum and also produces about 1.1 billion gallons of corn based ethanol each year. The San Antonio based company also operates thousands of filling stations and convenience stores in the US and Canada. In Q2 2012 the board approved separation of the retail segment. When the company last reported it hadn’t yet decided exactly how the separation would go down. One idea was a tax-efficient distribution to shareholders. There’s a good chance the company will announce its retail business separation plans during the October 30 earnings call.
Expect lower capital expenditures and higher distributions
Since March of 2011 Valero’s dividend yield has steadily increased each quarter from 0.67% to 2.49%. I am expecting that yield to grow for two reasons. First, I want to see more concrete plans for separating the retail business and in turn distributing the proceeds to shareholders. Second, the company has shelled out a heap of cash for its “Hydrocracker” facilities, but the floodgates should now be closed. As of Q2 2012 most of the capital necessary to complete the projects was already spent. I won’t consider the Q3 report a success unless the company maintains its own completion and cost targets. They are:
- Port Arthur Hydrocracker completion during Q3 2012
- Port Arthur Hydrocracker operational during Q4 2012
- Port Arthur Hydrocracker total investment of $1.51B
- St Charles Hydrocracker completion during Q1 2013
- St Charles Hydrocracker operational during Q2 2013
- St Charles Hydrocracker total investment of $1.525B
The Ins and Outs of the Refining Business
Feedstock and end product prices are notoriously volatile, so are Valero’s margins. As an independent refiner a great deal of feedstock and end product pricing is beyond their control. That doesn’t mean I don’t expect some strategy from management for making both as efficient as possible.
Corn futures popped at the end of Q2 2012 and were about 35 percent higher for all of Q3 2012. At the end of the second quarter Valero had stopped production at two of its ethanol plants, and lowered production at others. It expected throughput volumes of 3 million gallons per day in the third quarter with operating expenses of about 36 cents per gallon. I doubt the company will meet these expectations, but I will be looking for some strategy for dealing with potentially high corn prices throughout the fourth quarter.
Internationally Valero is well positioned to take advantage of less expensive feedstocks from abundant shale oil and gas in the US and Canada. Refining cash operating expenses were expected to be around $3.85 a barrel. Crude oil throughout Q3 2012 bounced around some, but was not much different overall from the second quarter. I want to see the company hit their operating expense expectations or there will be blood.
Amongst its Peers
Dividend Yield | Return on Invested Capital | EBITDA Margin TTM | Operating Margin TTM | |
| Valero Energy | 2.45% | 7.17% | 3.48% | 2.36% |
| HollyFrontier Corp. | 1.55% | 24.17% | 13.51% | 12.46% |
| Marathon Petroleum | 2.53% | 19.11% | 5.94% | 4.79% |
| Tesoro Corp. | 1.27% | 12.04% | 5.32% | 3.96% |
| Western Refining | 1.25% | 11.99% | 6.42% | 4.98% |
Among independant refiners Valero Energy might offer a better dividend yield than all but Marathon Petroleum Corporation ), but until its large hydrocracker facilities come online, I fear its margins will remain strained. The company has been investing a heap on two large hydrocracker projects that will produce highly profitable distillates, from low quality feedstocks. The Port Arthur, and St. Charles hydrocrackers are scheduled to become operational in Q4 2012, and Q2 2013. Total investment in the two projects is just over $3 billion. Once operational they should add about $1 billion (EBITDA) worth of black ink to Valero's income statement each year based on 2011 crude oil and end product prices.
Until Valero's huge investment in the hydrocracker facilities begins adding to their income statement the company's operating margins will lag well behind smaller, more nimble peers like HollyFronteir ), Tesoro ), and Western Refining ). This is why I think the most important thing to watch for when the company reports Q3 earnings is progress on those investments.
Buy or Sell Without Prejudice
Now that you know what to look for, it should be a lot easier to decide for yourself whether or not Valero Energy truly had an impressive third quarter. A total of 18 analysts are estimating EPS for Valero of between $1.32 and $2.06, so someone is going to be “surprised.” Armed with your own criteria for a successful report, you should be able to cut through the chatter.
crenauer has no positions in the stocks mentioned above. The Motley Fool owns shares of Western Refining. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
