Profitable Last Year, Valero Faces Deep Trough In 2020 Demand (NYSE:VLO)
Valero Energy Corporation (VLO) is an operationally solid U.S. refiner facing a once-in-a-generation demand loss from the global COVID-19 pandemic. The daily demand loss, estimated to be as much as 15-20%, has been caused by massive air (jet fuel) and automobile (gasoline) travel restrictions: the increase in commercial delivery vehicle fuel demand (gasoline and diesel) does not offset the other two. Much of the U.S. – the company’s primary market – is under shelter-in-place restrictions that are scheduled until at least April 30th.
Valero has accordingly experienced a drop in stock price, due both to the overall stock market drop and exacerbated by its sector-specific demand issues. The company is making changes such as using its ethanol plants to produce hand sanitizer. The entire refining sector is reducing throughput, which is usually highest in the spring months, and leaning away from gasoline and towards distillates in the product slate.
Nonetheless, Valero’s market capitalization drop and high dividend yield of 8.5% show the vast uncertainty now and ahead for at least a few months in relation to the size (barrels per day) and length (number of days) of the demand disruption affecting most global transport, consumer, and retail sectors. Although its market is mostly domestic, U.S. refiners export into the world market.
Dividend and capital gains hunters interested in Valero’s upside potential should be highly cognizant of the expected reduction in its 2020 revenues and income.
Analysts’ estimated 2020 earnings per share (EPS) is less than Valero’s current dividend. However, while Valero could choose to cut its dividend, at the end of last year the company had $2.6 billion of cash on hand and more than enough other liquidity to cover its dividend and debt.
Oil Prices, Supply, and Refining Margins
U.S. oil production in the week ending March 27, 2020 was near an all-time high of 13.0 million barrels per day (BPD). Because of low oil prices, U.S. producers are cutting budgets, so that total is expected to decline.
To add a market already in turmoil from the global pandemic, Saudi Arabia and Russia have decided to engage in an all-out price war by increasing supply. While in normal times the resulting lower oil price might have an elasticity effect on increasing demand, in global markets where government mandates have shut down so much transportation, this doesn’t occur.
The oil price drop in a small way benefits refiners like Valero; however, once again, the pandemic-caused steep decline in product demand completely overwhelms any advantage from a lower crude oil price, e.g., it doesn’t matter how cheap the input is if you can’t sell the output.
West Texas Intermediate price, Cushing, $/Bbl, Source: Macrotrends
The NYMEX April 6, 2020 closing oil price was a low $26.23 per barrel for West Texas Intermediate (WTI) crude oil at Cushing. The NYMEX closing RBOB gasoline price was also low at 70.78 cents/gallon ($29.73/barrel).
(Source: Energy Stock Channel)
The 3-2-1 crack spread, a measure of refining profitability or margin, is shown above. The sharp decline over the last month is evident.
These low margins reflect the excess of the supply of refined products over pandemic-lowered demand of between 15% and 20%. As a result, in what is normally the high-utilization spring season, U.S. refiners have cut runs to about 82% of capacity, down from an average in an ordinary year of 90% of capacity.
2019 Results Expected Higher Than 2020 Results
Valero’s 2019 net income was $2.4 billion, or $5.84/share, compared with $3.1 billion, or $7.29/share, in 2018. CEO Joe Gorder credited employee achievements in operational and environmental safety.
Valero is an independent oil refiner and marketer, one of the world’s largest. Its other two, much smaller, segments are ethanol – required as an input to gasoline – and renewable diesel.
In 2019, the company’s refineries ran at 93.6% of capacity, or 2.95 million BPD, slightly below the average for 2018. This 2019 throughput gave adjusted refining operating income of $4.04 billion.
Valero’s average throughput in the first half of 2020 will be much lower as it and other refiners have cut operations to meet reduced U.S. and global demand: refinery utilization is far off the typical spring levels.
According to the EIA, in 2018 the overall gasoline market was 143 billion gallons per year, of which 14.4 billion gallons was ethanol. Valero’s 2019 ethanol production volumes were 4.27 million gallons per day. This represented about 1.54 billion gallons/year. The company owns fourteen ethanol plants, and sales are made primarily to the wholesale gasoline blending market.
Adjusted operating income from the ethanol segment in 2019 was $4 million, down from $82 million a year ago.
However, investors should expect overall gasoline and ethanol volumes to be quite far down this year. In response, Valero has converted its Hartley, Iowa, ethanol plant to make hand sanitizer. The company is evaluating production of hand sanitizer at its other ethanol plants.
The renewable diesel segment includes the operations of Diamond Green Diesel. The company’s renewable diesel sales averaged 760,000 gallons per day in 2019, or 18,000 barrels per day, generating adjusted operating income of $576 million.
Valero has a total of 3.15 million barrels per day (MMBPD) of refining capacity in thirteen refineries in the U.S., one in Canada, and one in the UK. Its closest competitor is large independent refiner Marathon Petroleum (MPC). Other competitors range from international integrated corporation Exxon Mobil (XOM) to smaller companies like Delek (DK).
The barriers to the US refining industry remain high due to siting issues, the large, fixed cost of capital assets, a domestic market that is not increasing, and a regulated, consumer-facing gasoline business that is highly competitive and much-scrutinized.
As the overall U.S. numbers show, refiners like Valero have adjusted to these circumstances by reducing refinery runs (volumes) well below the normal spring schedule and cutting the percentages of gasoline and jet fuel produced in favor of distillates.
Valero also declared force majeure on distiller grain shipments and corn purchases last week, and temporarily closed 270 million gallons of ethanol capacity in two plants in Nebraska and Iowa. Other companies have done the same.
As of December 4, 2019, Institutional Shareholder Services ranked Valero’s overall governance as a 3, with sub-scores of audit (1), board (3), shareholder rights (6) and compensation (3). In this measurement, a score of 1 represents lower governance risk and a score of 10 represents higher governance risk.
Approximately 2.6% of the floated stock is shorted, and insiders own only 0.35% of the company’s stock.
Valero has delayed its annual meeting about a week until April 30th and will hold it online only.
Financial and Stock Highlights
Valero’s April 6, 2020 closing price was $46.10/share, up 14.3% on the day, much ahead of the Dow Jones Industrial Average increase of 7.7%. This share price translates to a market capitalization of $18.8 billion, well under its June 2019 capitalization of $32.6 billion and the June 2018 capitalization of $48 billion.
The company’s one-year target price is $82.82. Valero’s 52-week price range is $31.00-101.99 per share, so its April 6, 2020 closing price of $46.10 is only 45% of its one-year high.
Trailing twelve months’ EPS was $5.84, giving a trailing price-to-earnings (P/E) ratio of 7.9; however, analysts’ average projected 2020 EPS is a significantly lower $3.83 for a forward P/E of 12.0.
As of December 31, 2019, the company had $31.32 billion in liabilities and $53.86 billion in assets, giving Valero a liability-to-asset ratio of 58%.
The company’s trailing twelve months’ operating cash flow was $5.53 billion and its levered free cash flow is $2.58 billion.
A large, established public company, Valero’s dividend is $3.92/share for a substantial dividend yield of 8.5%. Note that this dividend is more than analysts’ average 2020 estimated EPS of $3.83. While unlike Chevron (CVX) Valero has not explicitly said it will protect the dividend, it does have a long history of paying dividends, and at the end of 2019, the company had an ample $2.58 billion in cash, or $6.31/share on hand.
Overall, the company’s mean analyst rating is 2.4 – or “buy” leaning toward “hold” – from the 21 analysts who follow it.
Its beta is 1.76, representing volatility well above the overall market average, surprising for a company of its large size, although indicative of the multi-factor squeeze (oil price; countered by jet, gasoline and diesel prices and demand; ethanol requirements; international tariffs; and domestic regulations) on refining margins.
Note on Valuation
The company’s book value per share of $53.27 is above its current market price, an indicator of negative investor sentiment.
Positive and Negative Risks
Potential investors should consider their expectations about refined product demand recovery from its current steep decline and their expectations about refining margins as the factors most likely to affect Valero.
A positive factor is that unlike upstream energy companies, Valero benefits from lower oil prices. Investors should nonetheless realize that the demand loss due to worldwide pandemic shutdowns swamps the crude feedstock price benefit.
Recommendations for Valero
Valero has come into this demand destruction downdraft as a fundamentally healthy company. However, with global gasoline, jet, and diesel demand far below historical levels, the situation bears watching for further clarification.
Some growth investors may consider waiting for three pieces of information: first-quarter financials, which will include all-important results from March; guidance from the company about the results of its actions to offset the demand loss; and news on the resumption of U.S. and global business and trade. For example, the shelter-in-place guidance at federal and most state and local levels is presently set through April 30, 2020.
Other growth investors may be optimistic about a faster refined products demand rebound.
Dividend hunters will find the company’s 8.5% dividend of particular interest. While there is no guarantee the dividend won’t be cut, despite reduced revenues, the company’s cash reserves and overall liquidity appear more than sufficient.
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Disclosure: I am/we are long VLO, CVX, MPC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.