While weak oil prices are wreaking havoc on producers' profits, they've been the fuel for robust profitability by refiners. That was clear by reviewing Valero Energy's (VLO 0.86%) third-quarter results where it clearly cashed in on low crude prices. The strong market conditions were really the key theme of the company's third-quarter conference call with CEO Joe Gorder highlighting five ways the company is cashing in on this opportunity.
1. We're being incentivized to run at nearly full capacity
The first thing Gorder pointed out about the market is the fact that, "Favorable product margins, which were supported by strong demand during the quarter, incentivized us to run at high utilization rates." In other words, because refining margins were so strong last quarter, Valero did everything it could to process as much crude as it could run through its system. According to John Locke, the company's Executive Director-Investor Relations, Valero's,
Refining throughput volumes averaged 2.8 million barrels per day, which was in line with the third quarter of 2014. Our refineries operated at 96% throughput capacity utilization in the third quarter of 2015 in spite of unplanned downtime, including the refinerywide outage at our Texas City refinery due to a lightning strike.
The company had to work extra hard to overcome some unplanned downtime but did so because the margins that could be earned during the quarter were just so tantalizing.
Photo credit: Flickr user David Stanley.
2. Our strategic investments are just about to pay off
A key focus of Valero has been to invest to upgrade its system to increase its access to, and processing capabilities of, cheaper North American crude oil. Those investments are about to pay off. According to Gorder,
We expect to see contributions in the fourth quarter from our recently completed McKee crude unit expansion, Port Arthur hydrocracker expansion, and from delivered crude off of Enbridge's (ENB 2.83%) Line 9B. Additionally, we're making good progress on our two crude unit projects. The Corpus Christi crude unit is ahead of schedule and is expected to start, with a start-up date of December 1. We expect start-up of the Houston crude unit around the end of the first quarter of 2016, as scheduled.
When these projects go into service over the next few months they are expected to improve the company's margins even further.
3. We're returning a lot of cash to shareholders
Because its refining margins are so strong, Valero is generating a ton of cash flow above what it needs for these investments in system upgrades. That is leaving it with an abundance of cash to return to shareholders. According to Gorder,
[...] Over the first nine months of this year we've delivered a 73% payout of net income, so we're on track to hit our 75% target for 2015. Additionally, the Board of Directors approved a 25% increase in the regular quarterly dividend, which is the second increase approved this year.
Most oil companies have suspended share buybacks and many of the weaker ones have even ceased paying a dividend. Valero, on the other hand, has been buying back its stock hand-over-fist with John Locke noting on the call that it has bought back 35.5 million shares for $2.2 billion this year. Further, it has increased its dividend twice this year when most other energy-related companies aren't even able to maintain the current dividend rate.
4. We continue to use our MLP to capture value
Aside from the strong cash flow Valero is generating via its operations, the company is also cashing in on the value disconnect between refining assets and assets owned within MLPs. We can see this by comparing the trading valuation -- measured by Enterprise Value-to-EBITDA -- of Valero and its MLP.
VLO EV to EBITDA (TTM) data by YCharts
This disconnect is why the company continues to strategically use its MLP, Valero Energy Partners (NYSE: VLP), to purchase MLP appropriate assets from Valero with Gorder noting on the call that, "We also executed another dropdown transaction earlier this month to Valero Energy Partners, which is our sponsored MLP." The company plans to continue to drop down assets to Valero Energy Partners to capture the higher value investors place on MLP assets with plans to sell $1 billion in assets to its MLP next year. Those transactions will provide it with even more cash that could be used for a variety of strategic initiatives such as buying back more stock, bolstering its balance sheet, or even making a strategic acquisition.
5. We're optimistic on 2016
In looking at what lies ahead, Gorder said that,
While we are seeing some seasonal pressure on product margins today, demand for our products remains strong and crude oil markets continue to be well supplied, so we maintain our favorable outlook for 2016.
In other words, Valero doesn't see any speed bumps slowing down the strong refining market, which is why it expects 2016 to be a solid year for the company. Further, the company is also poised to benefit from the strategic projects it is placing into service as well as additional drop downs to Valero Energy Partners, both of which should bolster its cash flow and financial position in the year ahead.
Investor takeaway
Valero is really thriving right now. It's cashing in on low crude prices and is poised to capture even more value after its strategic investments come online over the next few months. Further, it is also capturing the value disconnect of some of its assets by moving them over to its MLP. This is driving strong cash returns for investors, which appear poised to continue given the favorable outlook the company has for the year ahead.
