Valero Energy (NYSE:VLO) reported earnings of $503 million in the second quarter and maintained average refinery throughput volumes of over 2.8 million barrels per day. At first glance, these numbers look great and seem to indicate the potential for a strong second half. If you dig a little deeper in the earnings announcement, however, you might find some alarming numbers. Here's what they mean, and why Valero is still in good shape for the long term.
Valero has a lot to be happy with in its second-quarter performance. Its $503 million in earnings came in well above its first-quarter earnings of $283 million, and its refinery throughput was at 2.827 million barrels per day, which is actually a drop from the first quarter's impressive 2.879 million. Additionally, cash and temporary cash investments increased to over $4.9 billion, giving the company considerable flexibility to invest or weather future market downturns.
Additionally, the company felt comfortable enough with its cash flows to return $683 million to its shareholders through dividends and share buybacks. And its debt-to-capitalization ratio stayed at a very manageable 27%.
In terms of Valero's earnings, it shouldn't come as a surprise that the majority of the company's income was driven by its refining business. Its second-quarter cash flow from operations was $2.3 billion, and its adjusted refining operating income was $954 million, which is almost 40% higher than its first-quarter refining operating income of $695 million.
Valero CEO Joe Gorder explained the impressive uptick thus: "Despite a challenging earnings environment, our operations generated $2.3 billion of cash during the quarter. Our advantaged refining portfolio in the U.S. Gulf Coast and our team's focus on safe, reliable, low-cost operations allowed us to continue delivering solid performance despite lower margins."
While those numbers all appear to be good news, there's still a lot to be nervous about. For starters, the $503 million in earnings beat the company's first-quarter showing, but is significantly lower than the $1.3 billion from the second quarter of 2015. The main concern is the depressed refining margins, which fell from $13.71 per barrel in the second quarter of last year to $8.91 per barrel in the same period this year.
The reduced margins led to a drop in refining operating income. Much like the overall earnings picture, while the refining operating income easily beat the first quarter, it's almost $1.2 billion lower than in the second quarter of 2015. Additionally, this quarter's refining operating income barely covered Valero's refining operating expenses, which, at just over $900 million, are very similar to the figure from a year ago.
In fact, the company acknowledged how alarming this trend is and stated that throughput volumes will probably decrease during the second half of 2016 as higher oil prices and an oversupply of stored petroleum products keep margins low.
Additionally, biofuel blending costs to the tune of $173 million added further pain to the company in the second quarter. The costs were primarily used to purchase credits known as Renewable Identification Numbers (RIN). A RIN is a number attached to biofuel to track its production and use. The U.S. Environmental Protection Agency recently released standards that require higher requirements for biomass-based fuel. Valero expects these costs to reach as high as $850 million on an annual basis, which is nearly double the amount it spent on credit costs in 2015.
Low refining margins will almost certainly hurt Valero's bottom line for the rest of 2016. Regardless, the company remains committed to its 2016 capital program of $2.6 billion to sustain and improve its operations; its refining throughput remains close to complete utilization; and its balance sheet is in great shape. Valero proved in the second quarter that even at rock-bottom margins, it can turn in solid earnings while taking care of its shareholders.
David Lettis owns shares of Valero Energy. 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.