VLO - Valero Energy Corporation

[elevator_pitch]

I recently wrote-up a brief thesis on oil refiner Valero.

 

The stock is a victim of both the broader energy sell-off (though crude oil is an input cost for the company) and the market’s current inability to look past a temporary dip in earnings. As the US economy recovers, though, I think VLO shares have ~60% upside potential over the next two to three years.

 

Link: https://elevatorpitch.substack.com/p/-low-oil-prices-are-not-a-problem

 

FYI, the company is announcing earnings tomorrow, though they already released preliminary Q1 results earlier this month. Near-term guidance, if provided at all, is expected to be terrible. The next couple of quarters, though, are no indicator of the business’s long-term cash flow potential.

 

I'd be interested to hear your thoughts.

[samwise]

Thanks. this was helpful. specially the long term chart on margins which are very volatile and I appreciate you sharing the work. I had this on my todo list, so happy that you shared. A few questions for you below.

 

I've looked at refiners briefly on the thesis that that refiners margins should not be impacted in any oil environment, except in a low capacity utilization (i.e. low demand or oversupply) state. Makes sense to me as they are the middle man and its hard to build a new refinery in the US for environmental reasons. Limited competition should lead to decent pricing power. But, on the other hand there are a lt of refiners and they do expand their old refineries. So refining capacity has grown a bit over time. Any views on industry structure and long term returns to the players?

 

Some refiners seem to have over-earned because US and Canada oil was landlocked and could be had cheaper. Is VLO exposed to this advantage going away in the future?

 

Why VLO and not any other refiner? E.g. Marathon is bigger, WEB invested in PSX didn't he? PARR seems to have some advantages being the sole refiner in Hawaii. So why is VLO your choice?

 

Long term you expect the capacity and margins to be volatile but average about the same as the last 15 years. So you expect no net income growth? You expect half the return from dividends (where a low buy price helps), and half from future buybacks (where future higher prices will hurt the returns). EPS should only grow due to the buyback. Did I understand you correctly?

[elevator_pitch]

I will post a fuller update later since VLO reported earnings today but just wanted to address your big picture questions.

 

I think PSX and MPC are both interesting but prefer VLO due to it being the closest to a pure play on refining vs. the other large caps in the space, which have more pipeline and retail gas exposure. PARR has a spotty operating history and doesn't pay a dividend.

 

The industry has generally been disciplined for a while about capacity additions, which has allowed VLO to maintain a double-digit ROIC (and it's why margin per barrel is not changed much).  Given how little variability there's been in US oil demand (and the current state of the economy) I'm not worried about too much capacity coming online.  It's hard for anyone to be super bullish about more need for refined products right now.

 

You're essentially correct on my view on the drivers of returns.  Oil demand has grown ~1% annually in the US over the past few years so there's potential for some net income growth but nothing significant.  I'm guessing the majority of returns will be from current dividends and dividend growth from share buybacks.  Check out page 7 of their most recent PDF (http://www.investorvalero.com/static-files/ead51e34-aff8-4d79-b48b-a4b495cc7c7a).  They've been averaging well over $1bn in buybacks the past few years.

[elevator_pitch]

FYI, VLO was up 15% on earnings yesterday.  Good news on the sustainability of the dividend from management.

 

Full update: https://elevatorpitch.substack.com/p/-updates-on-vlo-slm-and-bats-

[samwise]

It’s back to April prices. Has anything changed in your (or anybody’s view)?

 

The market seems to think that miles driven and flown will be permanently lowered, leading to lower oil demand and lower capacity utilization at refiners, and thus lower margins. If this happens, how competitive is VLO, (or SU, another integrated I am following). Do we see years of attrition before the refinery capacity rationalities? Does VLO survive if it keeps paying the dividend with not enough cash flow?