Valero Energy Corp. (NYSE: VLO) with a price target of $70. In this environment, we believe that a company’s balance sheet strength and place on the cost curve are critical, and favor those refining and marketing companies that are well positioned to manage a potentially long period of low oil prices. We believe that VLO is one of these companies as it benefits from its size, scale, and diversified business portfolio, which includes refining, midstream, chemicals, and marketing and specialty operations.
This diversification has proven valuable in different commodity price environments over the past few years, and, despite fluctuating refining margins, we believe the company’s cash flow is less volatile than that of most pure-play refiners.
In addition, VLO incurred a negative inventory valuation adjustment of $250 million.
Refining throughput volume averaged 2.5 million barrels per day, down 428,000 barrels per day from 3Q19. The adjusted refining operating loss was $2.48 per barrel. Valero’s refineries operated at 80% throughput capacity in 3Q20, down from 94% a year earlier.
The company produced 3.800 million gallons of ethanol per day in 3Q20, down from 4.006 million gallons per day in 3Q19.
The new segment reflects the growing importance of renewable fuels and the growth of Valero’s investments in renewable fuel production. The segment reported $184 million of operating income in 3Q20, reflecting the expansion of the Diamond Green diesel plant, up from $65 million in 3Q19.
EARNINGS & GROWTH ANALYSIS
Approximately 40% of the spending on growth projects will be allocated to the renewable diesel business.
Again reflecting the fallout from the coronavirus and our view that volume growth (though improving from 2020) will be slow to recover.
FINANCIAL STRENGTH & DIVIDEND
Fitch rates Valero’s debt at BBB/negative.
In 2019, it returned $2.3 billion to shareholders, down from $3.1 billion in 2018 and $2.6 billion in 2017. The company has $1.4 billion remaining on its existing buyback authorizations, but recently said that it would suspend share repurchases until energy markets improve.
On January 23, 2020, Valero raised its quarterly dividend by 9% to $0.98 per share, or $3.92 annually, for a current yield of about 9.5%. The company is targeting a payout ratio of 40%-50% and plans to maintain its payout.
Valero participates in the downstream segment of the oil and gas industry. As such, it is at the bottom of the food chain in terms of its ability to set prices. Refiners can be hurt by rising crude oil prices since crude oil is a primary input. They can also be hurt if gas prices rise too much, causing demand for gas to decline.
With a total capacity of approximately 2.9 million barrels per day, Valero is the world’s largest independent petroleum refiner and marketer. The company has 15 refineries and 11 ethanol plants in the U.S., Canada, the United Kingdom and the Caribbean.
The shares reached a near-term peak in early November 2019 and then a slightly lower peak in early January 2020 before bottoming with the market in mid-March. The shares then rose through early June but have trended lower since that time.
To value the stock on a fundamental basis, we use a peer and historical multiple comparison model, as well as a dividend discount model.
On October 26 at midday, BUY-rated VLO traded at $40.03, down $1.94.