Valero: Oil Investing 101
If you haven't purchased a Seville Report Quarterly Newsletter yet here is a chance to get an idea of what our quarterly newsletter looks like. Our review of Valero resulted in a passing investment grade. Since we've recently released a full report and the next quarterly report isn't until September 1, 2018, we wrote a mini report for Valero. We believe the company is worth an investment, and we feel the opportunity to invest in the company may pass by the time the next quarterly newsletter rolls around.
Our newsletters contain serious research, but written for the new and inexperienced investor. We attempt to not get to technical and we attempt to make it as simple as possible to read and understand. Ultimately we want to convert the reader of this mini report into a quarterly purchaser of The Seville Report Quarterly Newsletter.
So here is our free report on Valero, please feel free to forward and share the report. A PDF version of the report will be uploaded to our site shortly. Thanks for checking out The Seville Mini Report.
Note: The values in this report may have changed from the time this report was written and published.
Valero Energy Corporation (Valero) is an independent petroleum refiner and ethanol producer. The Company's segments include refining, ethanol and Valero Energy Partners LP (VLP). The refining segment includes its refining operations and the associated marketing activities. The ethanol segment includes its ethanol operations and the associated marketing activities, and logistics assets that support its ethanol operations. The Company owns logistics assets (crude oil pipelines, refined petroleum product pipelines, terminals, tanks, marine docks, truck rack bays and other assets) that support its refining operations. Some of these assets are owned by VLP, which is a midstream master limited partnership owned by the Company. VLP's assets include crude oil and refined petroleum products pipeline and terminal systems in the United States Gulf Coast and the United States Mid-Continent regions. Its refineries produce conventional gasolines, premium gasolines and lubricants, among others.
Before we get into why Valero is worth an investment, lets start off with some background to what led us to the oil and gas industry. Early in the year we noticed crude oil prices creeping up and closing in on $60 per share. This steered us to Erik Townsend's podcast Macro Voices, and an episode on the oil markets. The outlook from this podcast sent us looking for oil stocks. We reviewed Phillip 66, it rated a 'C+' when trading at $92. Phillip 66 has made a run since then. We didn't get a chance to really build a position before Phillip 66's stock started its move (we aren't complaining). As oil prices continued to rise we thought we had missed the boat on oil companies. Then after trading over $72 per barrel in late May 2018, crude oil started to decline, and now it's back in the $60s. All this meant was that we should restart our oil company review.
Now to Valero. Valero was an interesting review. Revenue isn't growing, net income isn't growing, insiders aren't buying, and it had a failing driver grade. With all of that it still rated a 'C+.' What contributed to Valero's passing grade? The company pays a dividend, the company is repurchasing shares, the company has quality growth prospects, and Valero has had four straight quarters of revenue growth. Revenue is expected to grow by 12% in 2018 according to Yahoo Finance estimates. Recently the company announced a long term deal to import gasoline, diesel, and jet fuel into Northern and Central Mexico. In May, the company acquired Pure Biofuels de Peru, which is the third largest fuel importer in Peru. The companies complex refineries allows it to process lower quality feedstock and should help it outperform its peers. Also Valero is expanding its logistics segment.
Several macro factors that have influenced our decision to invest in Valero are the rising global demand for oil and the recent OPEC decision to increase oil output (6/22/18), this will benefit Valero and other refiners. Saudi Arabia has lifted its driving ban on women, the country's Energy Minister believes this will boost demand for gasoline. Also, the decision to not recommend reallocation of RIN waiver costs from small-refiners to large refiners like Valero will likely go unchanged.
Reviewing oil companies for investment can be difficult, there is a lot of information about oil supply and demand that we could take into account, and we do. However, we try to treat oil companies like we do any other company. We want to know what does the company look like now and will it look better or worse in five years. What will make it better? What could make it worse? If all variables remained as they are now would the company be a good company to own five years from now? With Valero we believe it is a good company to own.
As with all investments, an investment in Valero has its risks. There is a risk that Russia and Saudi Arabia will get permission from OPEC to increase their oil output. The increase in output will make up for the reduced outputs from Iran and Venezuela. With rising global demand for oil this doesn't appear to be a risk, but should demand for oil decrease this could drive the price of oil down.
Valero's balance sheet left us with some cause for concern. For one at the end of 2017 the company had more debt than cash, cash equivalent, and short term investments. Then there is the up and down revenue on the income statement . We prefer revenue growth or relative stability to the growth-decline-growth-decline revenue that Valero has experienced. We'd also prefer a better return on asset and return on capital than what Valero offers. Our review using Valero's 2017 annual report produced a lower profit margin and gross margin than the industry and sector averages. A few things contributing to the lower margins that stood out to us were the higher cost of biofuel credits in Q1 2018, the increase from $146 million in Q1 2017 to $206 million Q1 2018 caught our attention. It is believed that the EPA will not reallocate small-refiner RIN costs to large refiners like Valero as we stated earlier. Hopefully this will keep biofuel credit expenses manageable. This will be something we will continue to monitor quarter to quarter. Also the lower discount on crude oil stood out. Here is how it was explained by Valero in their first quarterly report of 2018.
"Lower discounts on crude oils. The market prices for refined products generally track the price of Brent crude oil, which is a benchmark crude oil, and we benefit when we process crude oils that are priced at a discount to Brent crude oil. While we benefitted from processing crude oils in the first quarter of 2018, that benefit declined compared to the first quarter of 2017. For example, ASCI crude oil processed in our U.S. Gulf Coast region sold at a discount to Brent crude oil of $4.88 per barrel in the first quarter of 2018 compared to a discount of $5.05 per barrel in the first quarter of 2017, representing an unfavorable decrease of $0.17 per barrel. Another example is Maya crude oil, which sold at a discount to Brent crude oil of $9.46 per barrel in the first quarter of 2018 compared to a discount of $9.93 per barrel in the first quarter of 2017, representing an unfavorable decrease of $0.47 per barrel. We estimate that the reduction in the discounts for crude oils that we processed in the first quarter of 2018 had an unfavorable impact to our refining segment margin of approximately $268 million."
There is also the rising popularity in electric vehicles, however we don't see this as a major threat to the oil and gas industry quite yet. Our reasons for this revolve around vanity. Good looking or sexy electric vehicles aren't cheap and cheap electric vehicles aren't sexy. There's a population of people that want to save the planet, and they will spend whatever and drive whatever it takes to help the planet, and that is admirable. However, we believe there is a larger population that still wants to look "cool" and a Chevy Bolt or Nissan Leaf doesn't do it. On the other hand Teslas aren't in everyone's price range. We believe it will be a few years for cool and affordability in the electric vehicle market to intersect.
With all of that taken into account we still see Valero as a solid investment.
The data for this chart was gathered from Yahoo Finance and Reuters.com.
Valero's P/E is right around the industry average, but above the sector average. When looking at the P/S, P/B, and P/CF we see nothing that screams value, as some values are lower than the industry average but higher than the sector average or vice versa. However the company's return on equity is second to only Phillip 66 (PSX) and is higher than the industry and sector averages. Then there is the profit margin which ranks towards the lower end when compared to the profit margins of the peers listed.
We have a wide buy zone for Valero, a lot of that has to do with the uncertainty of the markets right now. We would hate to be shaken out of an investment in a good company because of turmoil in the markets. Tariffs and changes in global trade will effect most every company out there, some companies will sputter for a while - as markets work themselves out - and shine in the long run; and other companies will sputter and then decline. We except Valero to sputter and then continue to grow. We don't expect Valero to drop below $100 per share anytime soon, unless something major happens in the oil markets or the fundaments of the company take a turn for the worst.
5/29/2018 Wells Fargo rates Valero a Buy with a $146 price target.
5/18/2018 Tudor Pickering rates Valero a Buy.
5/17/2018 Morgan Stanley upgrades Valero from Equal-Weight to Over-Weight.
5/10/2018 Edward Jones upgrades Valero from Hold to Buy.
Top Reasons to Invest in Valero
1. Growing global oil demand.
2. The company pays a decent dividend and is repurchasing shares (Yes we are fans of share buybacks).
3. Four straight quarters of revenue growth.
4. An increase in oil prices per barrel from this time last year.
5. Increasing 3:2:1 Crack spread since February 2018, this points to better margins for Valero.
Top Reasons to Avoid Valero
1. Up and down revenue and net income.
2. More debt than cash.
3. Based on 2017 10K, profit and gross margin were less than the industry and sector averages.
In January 2014 oil was trading at over $100 per barrel, oil prices took a big slide at the end of the 2014, and by the beginning of 2016 Crude Oil WTI was trading at $33 per barrel. In 2018 we find oil prices above $60 per share with growing global demand for oil. While most oil refinery companies will benefit from growing oil demand, we believe Valero's fundamentals and business structure put it in a position to out pace their peers and competitors in the future.