This Oil Refiner Is the Best

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

Editor's Note: Valero is not America's largest oil refiner, that designation goes to ExxonMobil. This version has been modified.

Valero (NYSE: VLO) is one of the largest retailers of petroleum products; however, the company plans to spin off this end of its business in the near future, which the company announced in July 2012.  Although revenues declined sharply after the oil price bubble of 2008, the company is doing better than ever, and in both of the past two years had higher revenue than it ever did before. 


<img src="/media/images/user_14267/vlo-revenue_large.png" />

As a result, shares are up nicely, gaining 135% from the sub-$20 prices seen during 2011.  Although I am completely in favor of taking some profits off of the table whenever you have a gain like this, I firmly believe that the best days for Valero are still ahead.

Valero owns and operates 16 oil refineries in the U.S., Canada, Aruba, and the United Kingdom. Among its petroleum products these refineries make are gasoline, jet fuel, lubricants, asphalt, and more.  The company markets its products through over 6,800 stores, however, the company plans to spin off its retail business. 

The vast majority of the company’s revenues are derived from the refining operations (82%), with the rest coming from the ethanol division and retail.  Valero owns 10 ethanol plants that are capable of producing 1.1 billion gallons per year, accounting for 9% of the company’s income.

According to a report by Bloomberg, Valero’s retail unit generates about $500 million annually, and may be worth as much as $5 billion as a separate entity, assuming a P/E ratio of 10.  The retail segment consists of over 1000 stations across the U.S. and Canada.  While in theory, this won’t change the intrinsic value of Valero, spin-offs tend to produce more value for shareholders than if the business remains as one.

Valero is investing more in its growth than ever before, which is a huge positive for investors.  The company plans to spend $1.915 billion on growth projects this year, as opposed to about $1.3 billion last year.

Valero is expected to earn $5.49 per share this year, and analysts expect this will increase to $5.68 and $6.09 in 2014 and 2015, respectively.  While annual earnings growth of just over 5% is nothing to get too excited about, consider that Valero trades at less than 8 times earnings, which is very cheap, even with relatively slow growth.

Until the spin-off is complete, the closest company business-wise may be Marathon Petroleum (NYSE: MPC), which is the refining and marketing segment of Marathon Oil that was spun off in 2011.  This company has done great for its shareholders, with higher-than-expected earnings results.  However, the company is forecast to earn $10.01 this year, which is expected to fall to $9.40 and $9.10 over the next two years, according to the consensus.

Also for comparison’s sake, let’s take a quick look at another big refining company, Tesoro (NYSE: TSO).  Let me start by saying that I love Tesoro as a company, and have for a while, even for when it was trading for under $7 in 2008.  However, I don’t like Tesoro as an investment right now. 

Due to a great 2012, the stock has gained almost 140% since last May, and I think the rally may be a little overdone.  Although the company looks very attractively valued at just 7.3 times 2012’s expected earnings, the company is supposed to have negative earnings growth for the next few years, a huge red flag for me. If I were invested in Tesoro, I would take my profits and wait to get back in at a better entry point.

So, of the three companies listed here, Valero is the only one with positive earnings growth, and the proposed spin-off could greatly benefit shareholders.  When you combine this with a low valuation, and ambitious investment in future growth, Valero looks like best-in-breed of the major refiners/retailers.



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