The Best Stocks for 2011: Valero Energy

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This article is part of our "Best Stocks for 2011" series where our Foolish writers pick their top stocks ideas for the year ahead. Click here to see a review of last year's picks and our 12 recommendations for the year ahead.

In the form it's in when first pumped out of the ground, oil is pretty useless. As it's refined into products like gasoline, heating oil, asphalt, and other petrochemicals, however, it becomes some of the most useful stuff on Earth.

Refiners -- the companies that make oil useful -- play a critical role in that value chain. None are better poised for success in 2011 than North America's biggest independent refiner, Valero (NYSE: VLO  ) . After a rough year of recovering from expensive refinery shutdowns amid industry overcapacity, Valero looks poised to have a more successful 2011.

Better than integrated majors?
2010 was a great year for the integrated oil giants. Other than BP (NYSE: BP  ) , which suffered huge oil-spill-related losses, the integrated majors rode oil's relentless climb to stupendous profits. Over the past four reported quarters, ExxonMobil (NYSE: XOM  ) earned more than $27 billion, Chevron (NYSE: CVX  ) earned more than $16 billion, and Royal Dutch Shell (NYSE: RDS-A  ) earned more than $15 billion.

And while there's every reason to believe that those integrated oil giants will continue to be tremendously profitable, these days their growth is largely tied to the price of oil. With oil in the $90s per barrel and fuel stocks near long-term highs, you have to ask yourself where future oil price growth will come from. Aside from speculation on the falling dollar, there's little fundamentally holding up the price of oil.

The thing about refiners like Valero, though, is that their profits are tethered to what's known as the crack spread, rather than the raw price of oil itself. And that spread seems to have essentially returned to normal, after the beating it took in the fourth quarters of 2008 and 2009. In essence, now that the bulk of that expensive downsizing is behind them, refiners are well-positioned to handsomely profit, no matter what the price of oil itself does.

Better than any other stock?
Like it or not, the world still runs on refined oil products. That's not going to change any time soon. And in a world where even major oil producers like Saudi Arabia need to import refined oil products like gasoline, wouldn't you want to own one of the biggest and best refiners out there?

What sets Valero apart in the refining business is something called "refinery complexity," where it tends to be near or at the head of its class. Its more complex refineries are able to handle lower-grade crude oil, which allows them to further improve their profitability when the spread between high- and low-grade oil increases.

On top of that advantage in oil refining, Valero is responding to new mandates for increased ethanol usage by aggressively buying ethanol production capacity. No matter what you may think of the true utility of increased ethanol, it is the law of the land. Along with Archer Daniels Midland (NYSE: ADM  ) , Valero is now one of two major ethanol producers in the country. That gives it a tremendous advantage as the new ethanol rules come into force.

In summary
Whether it's the energy demands of today's economy or the actual regulations driving the rules of the road for tomorrow, Valero is well-positioned to shine from an operational perspective.

From a financial perspective, it wasn't that long ago that Valero's stock traded hands for more than $77 a stub, which may have been a bit "irrationally exuberant." At today's prices closer to $23 a share and around 11 times next year's expected earnings, it's a fundamentally strong business available at an attractive price. And even if the expected turnaround fizzles, at a price-to-book ratio of around 0.84, there's a decent margin of safety priced into its shares.

When looking for the best stock to own, is there really any more that you could ask for?

Which is the best stock for 2011? See all 12 candidates here.

At the time of publication, Fool contributor Chuck Saletta did not directly own shares of any company mentioned in this article, but his wife owned shares of Valero. Chevron is a Motley Fool Income Investor recommendation. The Fool owns shares of ExxonMobil. Try any of our Foolish newsletter services free for 30 days.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (22)

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.

  • Report this Comment On December 30, 2010, at 6:20 PM, 49cent wrote:

    They may make money, but why would you invest in a company that spends milloins to defeat clean air regulations, when there are plenty of other, socially responsible companies

    with equally good prospects.

  • Report this Comment On December 30, 2010, at 8:13 PM, TMFBigFrog wrote:

    Hi 49cent,

    A primary problem with many proposed regulations is a concept known as "The Law of Unintended Consequences." There are very real ways that a regulation may wind up actively backfiring or creating even more problems elsewhere.

    If you'd like to discuss specific clean air regulations that Valero has opposed, it might be worthwhile to talk about the relative merits of those regulations vs. the potential consequences.


  • Report this Comment On January 01, 2011, at 11:45 AM, agib wrote:

    Chuck -- I don't know what your first paragraph means. I understand your second paragraph to imply that you think that Clean Air Act regulations, at least some, are not worth it in terms of cost to the regulated community vs. benefits. I am troubled that a Motley Fool employee would imply that requiring Valero and other refineries and power companies to reduce NO2, SO2, mercury, particulates, and other air pollutants that have been proven to cost hundreds of thousands of dollars a year in health care costs alone, to say nothing of long term environmental damage, would imply that these benefits are not worth it. Regulations go through months of public comment and lobbying, so it is not as if they are sprung on the regulated community without restraint. As a former EPA employee, I can tell you that these companies can afford to comply with existing regulations. Many do and are still in business and are making plenty of money.

  • Report this Comment On January 01, 2011, at 1:55 PM, TMFBigFrog wrote:

    Hi agib,

    What I mean is simple --

    If you regulate something in the wrong way, you risk either making the problem worse or shifting the problem elsewhere and creating new ones due to the shift. That doesn't help matters in the slightest.

    As a former EPA employee, you're no doubt familiar with the "new source rules" for power plants. In effect, the way they operate, they encourage companies to keep around older, higher polluting power plants.

    The link below is to an abstract of a study that suggests that the rules may actually cause air pollution to be higher than it otherwise would have been by delaying upgrades and the like. ...


  • Report this Comment On January 03, 2011, at 6:34 PM, SteliosH wrote:

    "Like it or not, the world still runs on refined oil products. That's not going to change any time soon"

    This is a completely erroenous statement. Refining capacity is dramatically shifting to the East and shrinking in the West with monstrous brand new efficent refineries being built recently such as Reliance India, and also in Saudi Arabia. These are serving the local markets AND exporting refined products to the USA and Europe. Refining in the West is a dying no growth breed. The crack spread will fall as crude oil rises. Bet on producers and integrated companies, not strictly Western refiners.

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