Even though crude oil prices are on the rise, normally a gloomy situation for refiners, shares of Valero Energy (NYSE:VLO) have been on an absolute tear so far this year. Resilient refining margins and management's plan to give a lot of cash back to shareholders in the form of a higher dividend and significant share repurchases have sent shares up 22% since the beginning of the year. That's already on top of its impressive run in 2017.
In the refining business, it's hard to envision circumstances under which Valero can maintain the pace it has over the past 18 months. So let's take a look at the company's most recent earnings results to see what we can expect over the next year or so.
By the numbers
|Metric||Q1 2018||Q4 2017||Q1 2017|
|Revenue||$26.44 billion||$26.39 billion||$21.77 billion|
|Operating income||$922 million||$853 million||$640 million|
|Operating cash flow||$166 million||$1.66 billion||$988 million|
The two numbers worth discussing here are the sharp drop-off in earnings per share and operating cash flow from the prior quarter. Even though refining is a seasonal business, these drop-offs look stark. In reality, though, they aren't that bad. To start, Valero's results benefited immensely from a one-time tax benefit last quarter that added $1.6 billion to the bottom line. Adjusting for that benefit, the company netted earnings per share of $1.16, which makes this past quarter's results look more reasonable.
As far as cash flow is concerned, management noted that it had a $1.2 billion increase in working capital, which should draw down through the rest of the year. That headline number certainly didn't discourage management from returning cash to shareholders as it bought back $320 million worth of shares in the quarter as part of its massive $3.4 billion share repurchase authorization.
Even though Valero's bottom line is pretty much dictated by its refining segment, management still likes to break out its ethanol segment and the contribution from its subsidiary partnership Valero Energy Partners (NYSE: VLP). While both ethanol and Valero Energy Partners showed slightly improving results, they are barely needle-movers for the refining giant.
Despite rising crude prices, which should lead to a significant decline in refining margins, Valero's refining business was surprisingly resilient this past quarter as refining margins remained curiously strong across its entire business. Even its West Coast operations, habitually the worst-performing segment, was able to increase processing throughput enough to lower operating costs and turn a profit.
Valero ended the quarter with $9 billion in debt and $4.7 billion in cash and short-term investments. That is a slight deterioration from the prior quarter, but it is largely due to that significant working capital build. As that working capital gets drawn down, we should see these numbers improve.
What management had to say
A refiner is at its absolute best when it can exploit small inefficiencies in the prices of various crude oils and petroleum products. For refineries close to the coast, that typically means exporting product overseas to markets where prices are much higher. For those refineries without export capacity, it means finding sources of crude that sell at a discount to benchmark prices because of things like transportation constraints or the quality of that crude.
Valero's margins were surprisingly resilient this past quarter because of its ability to exploit these market inefficiencies through some logistics investments. According to CEO Joe Gorder, the company intends to expand that part of the business even more over the next couple of years.
We increased pipeline throughput during the quarter, which provided our Memphis refinery with greater access to Cushing and Midland crudes that are cost advantage versus LLS. We made additional investments in logistics to further reduce secondary costs and increase margin capture.
We acquired the SemLogistics Milford Haven fuel storage facility in Wales. We also entered into a joint ownership agreement with Sunrise Pipeline LLC, a new pipeline connecting Midland and Wichita Falls, Texas. Construction also continues on the Central Texas pipelines and terminals and the Pasadena products terminal. We expect these investments to improve flexibility in product and feedstock supply in our refineries when completed in 2019 and 2020.
Still room to run in 2018?
Shares of Valero have had a nice run over the past month or so. Suffice it to say, the market seems to like the company's plans to give back wads of cash to its investors and the bottom-line boost from the new tax rules. You can even see it in Valero's valuation as the stock currently trades at its highest level in 10 years based on its enterprise value-to-EBITDA ratio. Granted, we should expect the stock to trade at a higher pre-tax valuation multiple since those taxes take less away from the bottom line, but it's worth being slightly more apprehensive about buying this stock than a few months ago.
What's worth watching over the next few quarters is whether the company can maintain these strong cash-generating results so it can fuel its share repurchase program. Until some of those margin-enhancing projects Gorder mentioned come on line, share repurchases and a lower stock count will likely be the driving force for its earnings per share.