The following article is part of The Motley Fool's "Stock Madness 2005," a contest based loosely on the annual NCAA College Basketball Tournament, a.k.a. March Madness. From March 17 to April 4, our writers and analysts will engage in head-to-head competition with each other, advocating and arguing on behalf of 64 stocks we've selected as among the most interesting to Foolish investors. You, dear readers, are the fans and referees -- you'll read these exciting duels and then vote for the stock you think is the better investment... and should therefore move on to the next round of play. The company that survives six "games" will be our tournament champion, and its writer our most valuable "coach."
But, please, make no mistake -- "Stock Madness 2005" is a GAME!
Our writers are doing this for fun. They are enjoying the spirit of competition and the art of debate. They are delighting in the search for positives in the companies they've drawn... and negatives in the companies they're pitted against. They are NOT necessarily recommending these stocks as the ones they believe in above all others. As ever, YOU must decide whether the stocks we're writing about -- winners and losers -- are deserving of your investment dollars.
Valero
San Antonio, Texas
$69.50
52-week low-high: $27.76-$77.15
$17.7 billion market cap
By Bill Mann
Is it just me, or does the name "Valero" remind anyone else of the Gipsy Kings?
OK, maybe it's just me.
Valero stands as the single best stock pick I've made since I arrived at The Motley Fool. I first wrote about it in August 2002 when it stood at $16.74 per share (split-adjusted), and today it rests above $69. I've had stock picks with higher returns, but this was the one I felt offered the best margin of safety I'd seen. Everyone hated oil services companies in 2002. Hated, hated, hated. But all I could see was a leveraged play on something that wasn't changing: U.S. demand for oil and refineries running near capacity with minimal chance of any more being built.
Trouble was, when you're making a countercyclical bet, you have to wait for the shift in the cycle. As it turned out, my wait was about two months. Oil prices started climbing, demand passed the inflection point, and Valero began its crawl from coyote ugly to one of the hottest companies in America.
Now, being a value guy, I get the hives just talking about a stock that has risen so quickly. But the basic economics that made Valero compelling in '02 haven't really changed. It still is the low-cost refiner since it has a higher percentage of its facilities fitted to process cheaper sour crude oil. There still is no chance for additional refineries to be built, and even though oil prices have spiked, the spreads between unrefined and refined products have expanded. Really, the biggest risk is that refined product demand will decrease because of continued increases in costs.
Meanwhile, there are worse places to be than the low-cost producer. Several years ago Valero made the expensive decision to convert many of its refineries to be able to handle sour (high sulfur content) crude instead of sweet. Recognize that the prices you see daily for "oil" are generally for sweet crudes, while sour trades a few dollars cheaper.
As long as the discount remains large enough, and the "crack spreads" -- or difference between the crude and refined prices -- are large, Valero will mint money.
Guess what? They're huge. And Valero still trades at a P/E of about 10.
I can hear it now. "Yeah, well, what happens when the price of oil drops?" It's the completely wrong question. Valero is a refiner, not a producer, of oil. It has no reserves. High prices per barrel ought to be -- all else being equal -- a negative for Valero. And yet Valero's CEO has said repeatedly that the environment for his company is simply fantastic. It's a perfect storm, and it's not ending soon.
Bill Mann owns no shares of any companies mentioned in this story.
TXU
Dallas, Texas
$79.97
52-week low-high: $27.15-$80.75
$23.4 billion market cap
By Tim Beyers (TMFMileHigh)
I'm not going to knock Valero. It's a good company, and Bill deserves kudos for doing well with the stock. It's just that I think Motley Fool Income Investor pick TXU, formerly Texas Utilities Company, is a whole lot more promising for your portfolio.
That's because the TXU investor has a head start on the Valero investor. Consider: TXU's 2.82% dividend yield easily bests Valero's 0.47% yield. So, for every $10,000 invested, Valero will pay you $47 annually. TXU, however, would pay you $282. Valero certainly could hike its payout given the more than $1 billion it generates in free cash flow annually. But TXU also has plenty of headroom. Its dividend accounts for only two-thirds of its trailing 12-month free cash flow, according to Yahoo! Finance.
Now let's assume that Valero's business is chugging along nicely, as Bill says. Can TXU keep up? You bet. In its most recently reported quarter, TXU juiced earnings by more than 400% after excluding discontinued operations and restructuring charges. More importantly, operating cash flow was up more than 40%. Though we don't know for certain, it's a good bet that free cash flow was up by roughly the same amount.
But the good news doesn't stop there. The company has sold off all non-utility assets and raised huge sums of cash to reduce debt and buy back more than 50 million shares. Now, the newer, lightweight TXU expects 2005 per-share operating profits to double while operating cash flow should again grow by 40%. All this from a company whose shares, priced at 36 times cash flow, could very well be trading at a discount.
Fool contributor Tim Beyers didn't own shares in any of the companies mentioned in the story at the time of publication. You can find out what is in Tim's portfolio by checking his Fool profile, which is here.
Rebuttals
Tim Beyers has laid out a fairly comely picture of TXU, and I'm gratified to see that the company has righted itself after dalliances in energy trading and other non-utility activities nearly dragged it into the soup. But in any good tease, the key is not to reveal too much. Unfortunately, Tim pulled the dress up a little too high. He says the company trades at 36 times cash flows (without really defining what he means by "cash flows"). I can think of few companies that deserve such a multiple ever. Utilities, which have to beg state utility commissions to enact price increases (just give me my 8%, pleeeeaaaaaaseee!), need not apply. -- B.M.
The Gipsy Kings? Don't you mean Dean Martin? Oh, wait. That's Volare. Also, didn't everyone on the boat die in The Perfect Storm? But Valero's problems run deeper than poor metaphors in this match-up, Bill. Indeed, the dividend mismatch alone puts your guys 20 points behind at tip-off. Add in TXU's expected cash flow gains this year and beyond, and it's easy to see that this one's a blowout. -- T.B.
Who won? Click here to cast your vote.
The Motley Fool is investors writing for investors.
