Better Buy: Calumet Specialty Products Partners LP vs. Valero Energy

Refining stocks turned in a solid performance across the board in 2017 thanks to improving margins fueled by cheap American shale and a growing opportunity in exports. While some of those positive forces will linger in 2018, rising crude oil prices could also create headwinds for some operators in the industry. That means investors will need to carefully evaluate any potential investments in this space.

For instance, consider a head-to-head matchup between Calumet Specialty Products Partners LP (CLMT -3.83%) and Valero Energy (VLO -0.32%). Shares of the former rose a whopping 92% last year, while the latter turned in a 40% return with dividends included. Both easily beat the 22% total return of the S&P 500, but there's a long list of differences between them.

Is one better positioned than the other and therefore a better buy right now?

Image source: Getty Images.

The matchup

Aside from the fact that Calumet Specialty Products and Valero Energy both rely heavily on the refining industry, these two companies couldn't be more different. One is a $525 million company that focuses on specialty products such as packaged consumer products, was on death's doorstep a few short years ago, and is now in the middle of an encouraging turnaround effort. The other is the largest independent refiner in the United States, with a $40 billion market cap and the enviable problem of trying to determine how best to spend its cash hoard.

But that doesn't mean the smaller company should be counted out entirely. After all, at just $7 per share, the stock is well below its 2015 trading range in the mid-$20s. If it can pull off a turnaround, then it could richly reward investors who are willing to take on some risk.

Calumet Specialty Products has certainly made things interesting by making progress more quickly than many thought possible. Management has shed unprofitable, slow-growing, and otherwise lackluster businesses to raise cash and let its core assets shine. Through the first nine months of 2017, the two laggard segments from previous years, fuel products and oil-field services, delivered impressive year-over-year improvements in both revenue and adjusted EBITDA. Meanwhile, the bread-and-butter specialty products segment doubled down on its highest-margin opportunities, increasing packaged and synthetic specialty products sales volumes 21% from the year-ago period.

The specialty products company appears to be on the right path. However, investors need to weigh two things. First, the year-over-year improvements last year were made possible by awful numbers in 2016. Progress may be harder to come by in 2018. Second, there's a long way to go yet, especially considering that Calumet Specialty Products increased its debt levels each year from 2012 to 2016. That damage to the balance sheet -- with its debt-to-assets ratio of 71% -- won't be undone overnight. 

Image source: Getty Images.

Valero Energy finds itself in a much better position, financially speaking, than its smaller peer. Two of its three segments, refining and Valero Energy Partners, delivered higher operating income last year than in 2016. The third business segment, ethanol, struggled along with the rest of the industry, but at least kept its head above water. The balance sheet is relatively clean, and gobs of cash flow are returned to shareholders in the form of a 3.5% dividend yield and a large share buyback program. 

Things could get even better in 2018 thanks in large part to the company's impressive concentration of refineries along the Gulf Coast. The region's proximity to major oil-producing regions and unparalleled infrastructure have allowed Valero Energy to fully exploit the opportunity in exports. Facilities there can run close to full tilt (they boasted a utilization rate of 96% during the fourth quarter of 2017) using relatively cheap inputs from nearby oil fields, upgrade the crude into higher-value products, and export it to destinations that lack the same confluence of market advantages.

Growing opportunities in exports helped Valero Energy end 2017 on a high note. During the fourth quarter of last year, the refining segment increased its operating income 18% compared to the same period of 2016. Although margins could face some pressure in 2018 from a tightening spread between West Texas Intermediate and Brent prices, American exports are expected to increase in the years ahead.

While I think it's clear that Valero Energy is a more stable investment than Calumet Specialty Products on the basis of operational and financial health, several valuation metrics bolster the argument:  

Data source: Yahoo! Finance.

The better buy is...

As the U.S. barrels toward energy independence and ships increasing amounts of energy and energy products across the globe, refiners with enormous scale and proximity to important oil-producing regions and export infrastructure will be the best-positioned to take advantage. Valero Energy is one of those companies. It's a better buy than Calumet Specialty Products because it's more stable, offers a healthy dividend, and presents fewer risks as an investment.

That said, it's possible for Calumet Specialty Products to deliver incredible returns if it successfully executes its turnaround plan. While the early indications are good, the hole dug from the last management team was pretty deep and will take quite a few quarters to escape. In other words, there's no need to rush into the stock, especially not with so much left to prove.