3 Bullish Arguments for Valero Energy Corporation

Here's why Valero Energy Corporation deserves your consideration.

Jun 12, 2014 at 9:42AM

Headquartered in San Antonio, TX, Valero Energy Corporation (NYSE:VLO) is a leading independent refiner with the majority of its 16 refineries and 11 ethanol plants located in the United States. Recent developments in the energy markets have put Valero Energy in a highly enviable position. This hasn't gone unnoticed by the investment community; Valero Energy's stock is up 45% over the last year. But this run could be just the beginning. Here are three bullish arguments for owning the stock at these levels.

Growth
The first quarter saw some gains in the traditional refining segment with operating income of $1.3 billion in the first quarter of 2014 versus $1.2 billion in the first quarter of 2013. But the really big news was from the ethanol segment, where operating income in the first quarter of 2014 was $243 million compared to $14 million in the first quarter of 2013.

Valero's Chairman and CEO Bill Klesse stated, "Our ethanol investments have contributed significant earnings and cash flow as we've improved the operation of the plants and benefited from favorable ethanol margins during most of our ownership period."

Management appears to have faith in the ethanol segment with continued capex. "In March, we acquired an idled 110 million gallon per year ethanol plant in Mount Vernon, Indiana, for $34 million. We plan to restart the facility and expect production will resume in the third quarter of this year."

That faith in ethanol could be justified with significant growth supported by doubling access to E85 across the country over the last seven years and rapidly increasing overseas demand. China appears to be leading the demand, increasing its total imports in 2013 to 9.7 million tons. Compare that to 2008, when imports accounted for 4.5 million tons. That's over a 100% increase in just five years.

But that spending is dwarfed by the $3 billion earmarked for "logistics," which is expected to be eligible for drop-down into its subsidiary, Valero Energy Partners LP (NYSE:VLP), a midstream master limited partnership. They plan to increase access to cost-advantaged crude, increase crude oil tank capacity, dock capability, and refined waterborne loading -- as well as light crude oil processing capacity. With U.S. exports of refined products increasing, investments in export infrastructure should play well over the long run and boost Valero Energy's presence in foreign markets.

USA
Growing domestic oil and gas production has proved advantageous to Valero Energy and the U.S. refining industry at large, according to a recent study by the EIA.

Earnings Per Barrel Processed

The report found that refining profitability across the three groupings tended to move together during the 2004-2010 period. European and North American refineries benefited from a broad increase in gasoline and distillate prices from 2004 to 2006, with profitability falling during the 2008-09 financial crisis. However, as the global economy recovered after 2010, many North American refineries benefited from relatively lower prices for two key inputs: crude oil and natural gas. Increasing production of both crude oil and natural gas contributed to lower feedstock costs in North America compared to international prices.

Us Refiner Crude Acquisition Cost

Valero Energy's recent comments regarding this issue seem to confirm this finding. "We remain on track to deliver on our strategy for generating long-term shareholder value by leveraging our assets to take advantage of the increased energy production in North America," said Klesse. Going forward "we expect our well-positioned business will continue to benefit from the increased North American oil and gas production," he concluded.

Valuation
Right now, Valero Energy Corporation is looking downright cheap compared to other large players like Marathon Petroleum (NYSE:MPC) and Tesoro Corporation (NYSE:TSO).

MetricValero EnergyMarathon PetroleumTesoro CorporationIndustry Average
P/E 10.20  17.20  19.80 19.50
P/B 1.46  2.45  2.13 2.13
P/S 0.21  0.25  0.30 0.30
LT Debt/Equity 0.29  0.35  0.67 0.48
Expected FY 2014 EPS Growth Vs. FY 2013 52.24%  35.26%  101.07% N/A

Low debt, high value, and great expectations going forward are all highlights of Valero in comparison. While I am sure the 101% expected EPS growth for Tesoro grabbed everyone's attention, the stock appears to have factored in such expectations when looking at the higher valuation. If stocks with high expectations that are commanding a premium in comparison fail to deliver, significant pullbacks usually result. That's why the still-solid EPS growth expectations of 50% coupled with attractive value are preferable for long-term investors.

The payoff
Valero Energy Corporation looks poised to capitalize in two key areas: ethanol production and access to the U.S. oil and gas boom. Ethanol should see significant increases in demand, both domestically and abroad. Increasing availability, greater application use, and government regulations that attempt to control harmful emissions will all prove to be demand drivers going forward. The U.S. oil and natural gas boom is providing Valero with lower input costs compared to the rest of the world, which could increase profitability and/or help take market share through lower-end prices.

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James Catlin has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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