Valero’s CST Brands Spin-Off Should Fuel Shares of Both Companies

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Just days after Valero Energy Co. (NYSE: VLO) slumped following an announcement it will have to spend two to three times as much as it did last year to comply with federal ethanol blending requirements (due to the high price of credits it needs to buy under law), shares got gassed when the company reported a spin-off of its retail business.

The San Antonio, TX based international manufacturer and marketer of transportation fuels, petrochemical products and power, will distribute 80% of CST Brands Inc. For every nine shares of Valero stock as of April 19, shareholders will receive one share of CST Brands. The distribution is planned for May 1. CST Brands will trade on the NYSE under the ticker “CST.”

Valero will retain 20% of CST after the share distribution. It will then sell the shares “as market conditions warrant”---likely within 18 months

CST, also based in San Antonio, is expected to be one the largest independent retailers of motor fuels and convenience merchandise in the U.S. and Canada. The company has some 1,900 sites and employees nearly 12,000. Retail locations are expected to hold onto the Valero Corner Store banner.

The move is a good deal for Valero, CST and shareholders.

Valero CEO Bill Klesse said, “We believe the separated retail business will perform well and unlock value for our shareholders. In addition to its large and geographically diverse network of high-quality sites, the retail business has a long history of strong brand recognition and financial performance, as well as significant growth opportunities in merchandise, food service and new-build locations.”

Merchandise sales at U.S. Valero retail stores climbed to $303 million in Q4 from $293 million in the same quarter a year earlier.

Last year was Valero’s second best in history. The strong retail showing makes a case for why investors might look to round-up, top-off or buy shares of CST Brands.Market participants should find a separated Valero attractive too.

Several studies have found that spinoffs and their parents outperform the market, with spinoffs having an edge. Data from a 1993 article in The Journal of Financial Economics shows that spinoffs and parents outperformed the S&P 500 Index by an average of 30% and 18% respectively during the first three years of trading in spinoff shares.

Another study found that between 2000-2005, spinoffs surpassed market averages by 45% during their first two years. Parent companies meanwhile beat it by an average of 40%.

Valero could be held back some due to the increased amount it must spend for ethanol credits. It will shell out between $500 million-$750 million this year, up from $250 last year.

Refiners, including Phillips 66 (NYSE: PSX) and Tesoro (NYSE: TSO) have all cautioned the price spike in credits they must buy to comply with ethanol blending requirements will chip away at earnings. The cost of credits has soared from 3 cents per gallon in 2012, to more than $1 a gallon at one point this year.

Phillips could offset the credit costs with its expansion projects. The oil refiner plans to develop a natural gas liquids (NGL) fractionator (a process of cleaning natural gas) in Texas. It also recently signed agreements with a couple of companies to improve supplies of low cost North American oil to its domestic refineries.

Tesoro, currently a favorite among scores of hedge funds, ranks among the best in the bunch. Its varied operations should cushion the credit outlay. The West Coast refiner pulled off a coup last year when it snagged a large California refinery from BP for $1.175 billion. Taking into consideration other assets in the deal including pipelines, infrastructure, gas stations and the ARCO brand, it’s said Tesoro virtually paid nothing for the refinery.

That kind of savvy move is why Barclays’ calls it “our favorite stock in the group.”

However, Valero could easily become investors’ favored stock. Since its June low, shares have risen a whopping 128%, with more upside likely.

Operating 14 refineries mostly in the central U.S., Valero has easy access to cheaper WTI oil and lower transportation costs. CNBC’s Jim Cramer said, “Valero has become the most aggressive company to take advantage of our new found technologically derived oil riches.”

Thanks to ample earnings, near 2% dividend yield, and future prospects, Valero looks attractive. While Valero finds it best to separate from CST Brands, adding the spinoff to a Valero position makes a nice and natural  compliment.

Diane Alter has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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