By the time Valero Energy (VLO 0.86%) reported fourth-quarter 2019 earnings on Jan. 30, everybody was already aware that the refining sector of the oil and gas industry had had a rough season. So the stock market largely shrugged off Valero's slight year-over-year declines in revenue and adjusted earnings.

In spite of that, there were some bright spots in the report, not least that even the adjusted figures beat analysts' consensus by a lot. Here's what investors need to know.

Pipes lead to a refinery in the distance

Refiner Valero Energy is also a top player in renewable fuels. Image source: Getty Images.

By the numbers

Metric Q4 2019 Q3 2019 Q4 2018 % Change (YOY)
Revenue $27.9 billion $27.2 billion $28.7 billion (2.8%)
Net Income $1.3 billion $639 million $1.0 billion 30%
Adjusted Net Income $873 million $609 million $932 million (6.3%)
Earnings per Share (EPS), diluted $2.58 $1.48 $2.24 15.1%
Adjusted EPS, diluted $2.13 $1.48 $2.19 (2.7%)

Data source: Valero Energy. YOY = year over year.

The difference between the earnings under generally accepted accounting principles (GAAP), which show double-digit percentage gains over Q4 2018, and the adjusted figures, which show slight declines, is significant. Both figures handily beat analysts' consensus estimates of $1.60 per share. The adjustments that made such a difference were due to a retroactive blender's tax credit in the company's renewable diesel segment that was recorded in Q4 2019. 

However, although net income dropped in the company's biggest segment, refining, its ethanol segment saw a net profit instead of a loss, thanks largely to higher ethanol prices. Even after the blender's tax credit adjustment, renewable diesel net income also notched a 12% year-over-year gain. However, those two segments have very little impact on the overall company's bottom line:

A bar chart showing Valero's net income by segment.

Figures include adjustments. Data source: Valero Energy. Chart by author.

While it's good to see the two smaller segments outperforming, the company's refining operations are what makes or breaks its bottom line. And in Q4 2019, refining margins were down across the industry. 

Highlights from the quarter

  • Refinery utilization was high, at 96%, which allowed the company to capitalize on wider differentials in sour crude oil as opposed to sweet crude. Quarterly average refinery throughput of 3 million barrels per day (B/d) was roughly flat from Q4 2018. 

  • Ethanol production volumes were also flat from Q4 2018, averaging about 4.3 million gallons per day (gal/d). However, higher ethanol prices allowed the company to turn 2018's $27 million loss into a $36 million profit in Q4 2019. Meanwhile, average daily renewable diesel sales volumes were up by 17.2% year-over-year, to 844,000 gal/d in Q4 2019.

  • On Nov. 25, Valero announced that it had signed long-term agreements for the use of three new refined product terminals in Mexico, which are expected to start operations in 2021. Combined, the three terminals are expected to have storage capacity of about 2.4 million barrels.
  • Valero has numerous other growth projects in its pipeline, including the Pasadena Terminal, St. Charles Alkylation Unit, and Pembroke Cogeneration Unit, which are scheduled for completion this year. The expansion of the company's Cushing-to-Memphis Diamond Pipeline -- a joint venture with Plains All American Pipeline -- should be completed in 2021. The company projects completion of its Diamond Green Diesel plant expansion in 2021 and its Port Arthur Coker to be completed in 2022.

What management had to say

On the Q4 2019 earnings call, CEO Joe Gorder was frank about the industrywide issues the company faced during the quarter:

Overall, 2019 was a challenging environment for the refining business. We started the year with gasoline inventories at record highs and gasoline cracks at historic lows. We were also faced with narrow sour crude oil differentials for most of the year, primarily due to sanctions on Venezuela and Iran in addition to OPEC and Canadian crude oil production curtailments and differentials on inland sweet crude oils narrowed in the second half of the year with the start up of multiple new crude pipelines from the Permian Basin to the Gulf Coast.

Despite this challenging backdrop, our team demonstrated the strength of our assets and prior investments to improve our feedstock and product flexibility, allowing us to deliver another year of steady earnings and free cash flow. We demonstrated our crude supply flexibility by processing an annual record of 1.4 million barrels per day of North American sweet crude oil as well as a record of approximately 180,000 barrels per day of Canadian heavy crude oil in 2019. ... We also continue to explore growth opportunities in our renewable fuels business, which is already the largest in North America. 

Ups and downs

In the third quarter, when Valero outperformed expectations, its share price jumped. This quarter, it did the same, but shares barely budged. With so much volatility in the energy sector right now, it's tough to know what will happen in the first quarter of 2020.

Valero is hoping to grow its Diamond Green Diesel joint venture with Darling Ingredients, but it's going to take time to ramp up that side of the business. Similarly, the company's ethanol arm is too small to have a significant impact on performance. That leaves Valero as primarily a crude oil refiner, subject to the whims of the refining market. In Q4, that market wasn't particularly good for refiners. It may improve in Q1, as oil prices have dropped, which can increase refining margins. 

Valero's valuation has also dropped since Q3, and shares are now trading at about 13.7 times earnings. That's still on the high side of its historic levels, but investors interested in biofuels will probably want to keep an eye on Valero.