Here's a question for energy investors: Should you buy stock in Valero Energy (NYSE:VLO), or in Valero Energy Partners (NYSE: VLP) instead?
Surprise! One analyst thinks you can buy both. This morning, Jefferies & Co. announced it is initiating coverage of both Valero Energy stock, and its subsidiary master limited partnership Valero Energy Partners, and assigned buy ratings to both. As confirmed in a report on StreetInsider.com, the analyst believes that Valero Energy stock itself is worth about $66 per share (20% more than the shares cost today).
What's more, according to Jefferies, Valero Energy Partners is an even better bargain. The analyst's $53 target price implies 26% upside from today's cost of $42 a share. But is the analyst right about that?
Here are three things you need to know.
1. Partners in profit
The first thing you need to know about Valero Energy, and Valero Energy Partners, is that they are not the same thing. The latter is a subsidiary formed by the former in 2013. Valero Energy owns the majority of its master limited partnership, and as fellow Fool Aimee Duffy explained back at the time of the IPO, was set up in such a way that "when Valero Energy Partners makes money, most of it will go to Valero."
2. OK. So is Valero Energy Partners making money?
Indeed, it is.
Over the past year, Valero Energy Partners has raked in $156 million in profit, and paid out 51% of that profit to its investors, resulting in a dividend yield of 3.2%. That dividend yield is growing, however, such that next year, the expected yield on Valero Energy Partners is expected to climb to 3.6%.
What's more, valued at 17.2 times earnings today, analysts expect to see Valero Energy Partners grow its earnings at close to 14% annually over the next five years. When you add the dividend yield to that growth rate, total returns on the stock are expected to equal 17.5% over the period -- resulting in a PEG ratio of less than 1.0.
By way of comparison, Valero Energy stock costs only 8.9 times earnings, and pays an even bigger dividend -- 4.4%. On the other hand, analysts who follow the stock predict 10% annualized earnings declines for Valero over the next five years. Quite a difference.
3. Declines are bad, right?
Declining earnings would be bad for Valero. But according to Jefferies, they're not certain to happen. According to the analyst, Valero Energy Partners "has lifted cash payouts at a ~30% CAGR since its 2013 IPO & mgmt has articulated plans for 25% annual growth through '17." That's 25% growth in the high-margin revenue stream flowing into the parent company.
Analyst estimates found on S&P Global Market Intelligence lend further clarity to what's happening here. Last year, you see, Valero Energy earned $7.99 per share -- a number that's expected to fall off sharply in this year of low oil prices, and a number we probably won't see again anytime soon. But as early as 2017, S&P Global's surveyed analysts expect to see earnings begin rising again, and even in 2018, earnings should remain above 2016 levels ($4.89 per share projected, versus current year projections of $4.77).
And even at $4.89 per share, Valero stock would only cost about 11 times earnings at today's prices -- and those earnings would be growing, not shrinking.
One final thing: Which one to choose?
Both stocks have their attractions. Valero Energy proper offers investors a lower P/E ratio and higher dividend yield. Valero Energy Partners on the other hand, appears to cost more, but if management is to be believed, promises faster growth in dividend payouts -- and more certainty that they will rise as well.
Jefferies appears to believe both stocks are worth buying at today's prices. But me, I lean more in favor of Valero Energy Partners and its more attractive PEG ratio.