Valero Energy Corporation

Source: Flickr user Mike Mozart.

Valero Energy Corporation (NYSE:VLO) recently reported pretty robust second-quarter earnings. Those earnings were fueled by the company's ability to take advantage of the current market environment, which really favors refiners. That was a key theme on its second-quarter conference call, where the company referred to four ways it plans to continue to create value for investors:

1. Commitment to shareholders
CEO Joseph Gorder began the call by reminding investors that it clearly believes that strong shareholder distributions creates value for investors in the current environment. He said:

We continue to demonstrate our commitment to stockholders by exceeding our total payout guidance. As reflected in the earnings release, we've increased the targeted total payout ratio for 2015 to approximately 75% of net income.

At a time when so many energy-related companies are cutting or eliminating shareholder distributions, Valero is increasing distributions. For 2015, it expects to pay out 75% of its net income to investors via dividends and buybacks.

That being said, investors shouldn't bank on 75% of net income being paid out going forward. Instead, Gorder suggested:

Philosophically, we started the year saying we want to achieve a minimum 50% payout ratio. I think you could expect that if the business is performing, that would be a minimum that we'd like to live with going forward.

What's worth noting is that this only affects the share-buyback portion of the company's shareholder distributions as Valero plans to consistently grow its dividend over time.

2. Maximize its MLP's value
Part of Valero's commitment to its investors is to maximize the value of its assets. One way it's doing that is by dropping down midstream assets to its MLP, Valero Energy Partners (NYSE:VLP). Gorder provided an update on the company's dropdown plans, saying:

We continue to advance the next dropdown transaction to Valero Energy Partners LP...We've also completed our estimate of potential MLP-eligible EBITDA within our fuels distribution business. In that regard, we've identified approximately $350 million that may be eligible for dropdown transactions to VLP, which is incremental to the approximately $800 million of remaining EBITDA that we've previously identified.

In other words, the company has identified more than $1.15 billion in MLP-eligible earnings that can be dropped down to Valero Energy Partners over time. Because investors value MLP earnings at a higher multiple than refining assets, Valero can sell assets to Valero Energy Partners and unlock instant value for its investors. We can see just how steep the value disconnect is on the following chart.

VLO EV to EBITDA (TTM) Chart

VLO EV-to-EBITDA (TTM) data by YCharts.

3. Strategic growth projects
Another way Valero is looking to create value for its investors is through strategic growth projects. One that it's considering is a methanol project at St. Charles. In discussing the project, Gorder said, "We plan to have a final investment decision by the end of the fourth quarter." However, there's a bit more involved than just making a decision, which is something Lane Riggs, the EVP of refining operations, detailed on the call. He said:

The project still looks good. But...we are now trying to get the right deal with a partner to make this a good deal for our shareholders, and that's what we're working on currently. And we expect to have some resolution on that by the end of this year or early first quarter.

In other words, while the company likes the potential economics of the project, it won't move forward until it finds the right partner. While that's something it hopes to have in place by early next year, given the current market environment, there's still a possibility that the project could remain in a holding pattern for quite some time. That's because the company will only move forward when it has a project that will create value for investors. 

4. Open to M&A
Most of Valero's efforts to create value is focused internally on shareholder distributions, dropdowns to its MLP, and organic growth projects. That said, the company does continue to monitor the acquisition marketplace in search of value-creating opportunities. Gorder pointed out that the company has a "balance sheet here that's like gold-plated, and so we have plenty of opportunity [to make an acquisition] without using the equity to do that."

That said, he pointed out that the company isn't opposed to using its equity to "[...] do a very significant transaction. And although we don't have anything like that on the radar screen today, we could do fairly sizable transactions with the balance sheet as it sits today...it would be highly accretive transactions without negatively impacting things. Now that being said, we've looked at the market, we've looked at what's out there, and we just haven't seen anything yet that warrants us to do that."

So while the company has the capacity to acquire almost anything it finds compelling, it hasn't yet found a deal that would be highly accretive immediately. That said, if an opportunity does arise, investors can expect Valero to pounce.

Investor takeaway
Valero Energy is focused on creating value for shareholders. It's using a variety of tactics as it's increasing its distributions thanks to a robust cash flow while also continuing to move forward with dropdowns to Valero Energy Partners and growth projects like the methanol plant. Also, if the opportunity arises, it wouldn't hesitate to consider a large strategic M&A transaction if it created immediate value for investors. 

 

Matt DiLallo has no position in any stocks mentioned, and neither does The Motley Fool. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.