Valero Kicks It Old School

My beginning-of-the-year thesis on Valero (NYSE: VLO  ) , the second-largest U.S. refiner after ExxonMobil (NYSE: XOM  ) , continues to play out. After posting a narrower loss in the first quarter, the U.S. independent refiner delivered second-quarter profits, enabling investors to breathe a sigh of relief.

Income for continuing operations totaled $530 million, or $0.93 per share. In the second quarter of 2009,  the company lost $0.39 from continuing operations. Meanwhile, the recent quarter's operating income, or EBIT, came in at $921 million, versus a $192 million loss in the year-ago period.

Driving that zippy bottom-line performance were such catalysts as higher margins on refined products and deeper discounts on lower-quality crude inputs. However, management reported that the strength of these tailwinds has already waned somewhat. Similarly, integrated giant BP (NYSE: BP  ) cautioned in its Q2 release that it's expecting the "usual seasonal decline in refining margins" in the current third quarter, which follows the June-ish peak in U.S. gasoline demand.

And the thing is, this year's peak wasn't even that impressive. From May through June 11, U.S. weekly gasoline demand was below the five-year average. As for the current four-week average-demand number, it's only a shade above last year's figure. Rather than a sharp economic recovery, that's indicative of a slowdown in consumer activity.

In the company press release, CEO Bill Klesse remarked, "Valero makes and sells fuels, so we need consumers to get back to work and the economy to grow faster." At the same time, the company highlighted its historically low price-to-book ratio (currently 0.67) in a June investor presentation. Two thoughts here. First, when in an earnings release management essentially admits that it's hostage to a punk economy, then shares probably deserve to be bouncing along the valuation lows.

Second -- and I've argued this before -- what good is book value? Take the case of Valero's Delaware City refinery, which in a recent sale fetched a mere $220 million. Prior to the transaction, Valero had written down the book value of Delaware City by a whopping $1.4 billion.

Similar writedowns could be in the offing. Valero is exploring "strategic alternatives" for its Paulsboro operation, and the currently shuttered Aruba refinery will be reopened only "if conditions are profitable." Notably, the company's most recent 10-K warns that "the likelihood of a potential sale could result in a significant writedown of these assets." In other words, investors who are chasing book value could be in for a dose of vertigo.

Ultimately, Valero's story so far this year is one of sequential and year-over-year improvement, overshadowed by a dubious longer-term outlook. Shares, which are roughly flat on the year, could double, but only if we get a picture-perfect U.S. recovery, combined with further reduction of spare refining capacity.

In my view, investors would fare better wagering on a global economic recovery. Accordingly, I'd look to cyclical industries outside the refining sector, where DuPont (NYSE: DD  ) , Eaton (NYSE: ETN  ) , and Cummins (NYSE: CMI  ) , for instance, have all reported increased demand. Because of international exposure, investors can at least give these names the benefit of doubt -- something Valero may never be able to earn.

Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Mike Pienciak holds no financial interest in any company mentioned in this article. The Fool has a disclosure policy.


Read/Post Comments (0) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1250201, ~/Articles/ArticleHandler.aspx, 11/22/2014 10:59:54 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement