This All-Star Refiner Has Plenty Of Room For Growth

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Valero Energy (NYSE: VLO) has been reiterated by TheStreet Ratings as a buy on the basis of the company's strengths demonstrated in areas such as revenue growth, strong cash flow from operations, and a solid financial position with reasonable debt levels as well as good stock performance. The analysts are of the opinion that these strengths outweigh the below par growth in net income. Valero, through its subsidiaries, is an international manufacturer and marketer of transportation fuels and petrochemical products. Valero employs roughly 22,000 people, and its assets include 16 petroleum refineries with a combined throughput capacity of approximately 3 million barrels per day, 10 ethanol plants with a combined production capacity of 1.2 billion gallons per year, and a 50-megawatt wind farm.  In addition, approximately 6,800 retail and branded wholesale outlets carry the Valero and Diamond Shamrock brands.

Valero Energy has reported net income attributable to stockholders of $674 million, or EPS of $1.21 for the third quarter of 2012, compared to net income of $1.2 billion and EPS of $2.11 for the same quarter of 2011. Included in the third quarter 2012 results was a non-cash asset impairment loss of $341 million after taxes, or $0.62 per share, and severance expense of $41 million after taxes, or $0.07 per share mainly related to the Aruba refinery. If these one-off items are excluded; net income attributable to Valero stockholders works out to $1.1 billion, or EPS of $1.90.

Valero's third quarter operating income was $1.3 billion compared to $2 billion of operating income on a year-on-year basis. Excluding the above items, third quarter 2012 operating income was $1.7 billion. The decline in operating income was attributed by the company primarily to lower refining throughput margins in the U.S. Gulf Coast, Mid-Continent, and West Coast, which were no this was partially offset by significantly higher refining throughput margins in the North Atlantic region. In addition, throughput volumes at the St. Charles, Meraux, and Memphis refineries were negatively affected the effects of Hurricane Isaac and unplanned maintenance on the Meraux crude unit. Another contributory factor to the decline was the lower ethanol and retail margins.

Valero Chairman and CEO Bill Klesse noted that even with margins lower than the previous year, the financial results were solid. He added that during the quarter, the company reorganized the Aruba refinery into a crude oil and refined products terminal, carried out major-reliability work at the Meraux refinery, and continued to work on the separation of retail business. The new Port Arthur hydrocracker is expected to become operational in December, and the new St. Charles hydrocracker is on course to become operational in the second quarter of 2013.

Valero's retail segment reported $41 million of operating income in the third quarter of 2012 versus $97 million of operating income in the same quarter of the previous year. The decrease in operating income was mainly due to lower margins and volumes in the U.S. and Canada plus a non-cash asset impairment of $12 million. The ethanol segment reported an operating loss of $73 million in the third quarter of 2012 versus $107 million of operating income for the comparable quarter of the previous year.  The decline in ethanol operating income was attributed to significantly lower gross margins caused by a combination of high corn prices and high industry ethanol inventories because of lower ethanol and gasoline demand.  As a result, the company reduced production rates at several of its plants.

Capital expenditure was $784 million, of which $75 million in connection with turnaround and catalyst expenditures. The company paid $97 million of cash to shareholders by way of dividends on its common stock and ended the quarter with $2.5 billion in cash and cash equivalents.  For full-year 2012, the company has reduced its estimate for total capital spending, including turnaround and catalyst expenditures, to $3.5 billion against the prior guidance of approximately $3.6 billion. Total capital spending for 2013 is expected to be approximately $2.5 billion, including approximately $200 million for the retail segment and some expenditure carried forward from 2012.

Let's take a look at two other refiners. HollyFrontier (NYSE: HFC) earned a vote of confidence from Barclays which sent the stock soaring, and there is still considerable upside expected. HollyFrontier trades at only 6 times past earnings and generates a good amount of free cash flow which makes it significantly undervalued at the current price. Western Refining (NYSE: WNR) also looks reasonably priced because the forward earnings multiple is only just over 7 times and the company has strong cash flow generation.  It could be a prime acquisition candidate for a larger oil and gas company looking to integrate vertically because of its current market capitalization of around $2.5 billion. Anadarko Petroleum (NYSE: APC) has reported a quarterly profit of $121 million, or 24 cents per share, compared to a loss of $3.1 billion, or $6.12 per share in the same quarter of the previous year. It expects to produce 265 million barrels of oil equivalent to 267 million boe this year, higher than its second-quarter forecast for output of 261 million boe to 265 million boe. BP (BP) raised its dividend and the confidence that it can recover from its devastating U.S. oil spill, a re-engineered business in Russia and a renewed focus on exploration and production. The company also said that third-quarter underlying replacement cost profit fell to $5.2 billion from $5.5 billion a year ago.

To sum it up, Valero has performed particularly well, and despite rising almost 67% from its 52-week low, it is still trading at just around book value. Free cash flow generation remains strong at $1.9 billion and management is taking the right steps to unlock shareholder value. The retail business spin-off and cost reductions at the Aruba refinery should provide protection against rising costs. This looks like an attractive investment at the current price.


jordobivona 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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