Last year was a challenging one for refiners. Market conditions hit Valero Energy (NYSE:VLO) hard, causing its adjusted net income to plunge 63% to $1.7 billion. However, that didn't stop the refining giant from still being generous with its investors. Overall, it returned $2.4 billion in cash via dividends and buybacks, including spending $1.3 billion to repurchase more than 28 million shares during the year. That's a move that should have investors smiling, given the company's strong financial position and the meaningful impact the buybacks are having on the company's share count.
Following the money trail
While Valero paid out all its earnings, and then some, to shareholders last year, that decision didn't have an adverse impact on the company's financial situation. Cash flow from operations was much higher at $4.8 billion, which was just 14.1% below 2015's level. As a result, the company covered both its $2 billion capex program and its $2.4 billion return to shareholders with room to spare.
Further, the company generated incremental cash by dropping down assets to its MLP, Valero Energy Partners (NYSE:VLP). In March, Valero sold its McKee Terminal Services Business to its MLP for $240 million. Meanwhile, it followed that up with the sale of its Meraux and Three Rivers Terminal Services Businesses to Valero Energy Partners for $325 million in August. As a result, the company ended the year with a healthy cash position of $4.8 billion, up from $4.1 billion at the start of the year.
Making a meaningful impact without affecting anything meaningful
The other thing worth noting about Valero's buyback is that it's not merely for show. Last year, for example, the buyback reduced its full-year share count by 7.2% over 2015. Further, as the chart on the following slide shows, the company's commitment to repurchasing shares has significantly reduced its share count since 2011:
What's worth noting is that Valero's share count is now just 79% of what it was five years ago, which is better than the peer average of 89%.
One reason its share count is down more than those of its peers is a decision to allocate more capital to buybacks than to growth projects, as the company has a higher return hurdle for refining projects than its rivals do. For example, Valero requires a 25% internal rate of return (IRR) before it will sanction a refining growth project. Contrast that with Tesoro (NYSE:ANDV), for example, which has a 20% IRR return hurdle for refining growth projects.
Yet just because Valero has a higher return hurdle for new refinery projects, that doesn't mean it has limited its ability to grow. That's clear by looking at its 2017 capex budget, which will see the company invest $1.1 billion in growth projects, up from $600 million of growth spending last year. The company will use those funds to expand its Diamond Green Diesel Plant and build a new alkylation unit at its Houston refinery. These are large-scale projects that should enter service in 2018 and 2019, respectively.
Valero's capital discipline not only doesn't diminish its growth prospects, but it also pays off in other ways, including driving its ability to deliver peer-leading returns on invested capital (ROIC). Last year, for example, Valero's ROIC was 9%, while Tesoro's was closer to the peer average of 6%.
Valero Energy's buyback is a winner given the noticeable impact it's having on the share count. Further, the company isn't doing any harm to its balance sheet or growth prospects by allocating capital toward share repurchases. So investors should be happy to see that the company remains committed to continuing the buyback in 2017, already pledging to return at least 75% of its adjusted net income to investors this year.
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