Valero Energy Continues to Lose Ground, but Will It Last?

Will Valero Energy change course and rally in the near term? Will its second-quarter earnings report impress investors?

Jul 21, 2014 at 12:53PM

In anticipation of the release of Valero Energy's (NYSE:VLO) second-quarter report, the company released an interim update for the past quarter. This report puts its income from operating activities at a range of $1.10-$1.25 per share, or an average of $1.175 per share. This average is slightly below market expectations, which were set at $1.20 per share. Is the company's situation all that dire? Let's consider the good, the bad, and the uncertain regarding Valero Energy. 

The good
The company will report an increase in its throughput volume, mainly in the Gulf Coast. Moreover, it also expects to see a rise in its profit margin on account of higher discounts on sour oil over Brent oil prices. 

This was also the case back in the first quarter, in which the company recorded higher margins on sour oil.

The bad
But perhaps the ongoing fall in the spread between Brent and West Texas Intermediate crude oil, which could adversely affect its profit margin, is also dragging down Valero Energy's valuation.

Refinerries And Spread Q

Data from Google Finance and EIA

As the chart above shows, Marathon Petroleum (NYSE:MPC) maintained a lower profit margin than Valero Energy, as the former was more affected by the drop in the spread between Brent and WTI than the latter. This fall is likely to also adversely impact Valero Energy's bottom line in the coming quarters. But since sour oil margins continue to grow, Valero Energy is likely to keep increasing its profitability, as the improved margins on sour oil will keep offsetting the negative impact from the fall in the Brent-WTI spread. 

The uncertain
The weather will remain a major factor that could impede Valero Energy's progress in regions that are prone to bad weather conditions such as the Gulf Coast -- the company's biggest market, accounting for nearly 60% of its total throughput volume.

The other factor to consider is the U.S. Department of Commerce's ruling to approve Pioneer Natural Resources(NYSE:PXD) petition to export ultralight oil. This news prompted a sharp fall in shares of many U.S. oil refineries. Some analysts speculate this ruling could be enough to open the floodgates for other companies to export ultralight oil and thus reduce the margins of U.S oil refineries (as the market opens up to competition from Asia). 

It's still uncertain how this ruling will impact the margins of oil refineries because it only relates to a specific kind of oil and doesn't apply to all companies. But this uncertainty has played against Valero Energy, Marathon Petroleum, and other big oil refineries since this news was published. This could also imply the market may have overreacted, and thus these companies could see a comeback in the coming months.  

The drop in these stocks led to a rise in their divided yields: Valero Energy's annual yield is close to 2.05% and Marathon Petroleum's yield is about 2.2%. If Valero Energy continues to improve its profit margin, this could eventually lead its management to increase its dividend payout. 

The ongoing fall in shares of Valero Energy may have been a bit too harsh. The company continues to improve its profit margin and increase the volume of operations; it doesn't have much debt on its balance sheet, and it pays a reasonable divided. These factors are likely to eventually bring shares of Valero back up.

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Lior Cohen 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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