Valero Energy, an attractive 4% Dividend Yield Play


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Introduction

I am always searching for profitable dividend growth companies for my Fiorente portfolio. In my portfolio are companies that have a good credit rating and a healthy growth in revenue and cash flow. An increasing dividend payout history and a good credit rating are key criteria, as well.

In finding these opportunities I normally use a list of dividend growth companies, originally created by David Fish. David maintained a list now consisting of 867 dividend growing companies. These companies have a minimum of 5 year of increasing dividend growth each consecutive year.

This month (Feb 2019), I filtered this list on credit rating (excluding lowest BBB+ and no ratings), low PE (<17) and a Debt to capital ratio of below 70, to create a manageable list of approximately 130 stocks. These stocks are currently trading at an attractive fair value or below their intrinsic value and have a reasonable risk profile. I further sorted this list on the expected EPS growth by analysts, in search for companies that have an above average growth expectation. One-third of this list, 42 stocks, had an above average expected growth of more than 10%. From these 42 attractive candidates, Valero Energy Corporation (VLO) came to the surface as number 1 on this criterium. Valero has an estimated EPS growth of 34.1%.

According to the U.S. Energy Information Administration, International Energy Outlook 2017, the world demand for energy will grow around 28% between 2015 and 2040.

All reasons for me to look into this refinery company again.

Company background

Valero Energy Corporation (VLO) is a midstream as well as a downstream energy company. It is an independent petroleum refining, ethanol and renewable diesel producing company. It operates through three segments: Refining, Ethanol, and Renewable Diesel.

Valero does not drill oil, but refines oil and sells its products.

Valero sells its products in both the wholesale rack and bulk markets, and approximately 7,400 outlets carry Valero’s brand names in the U.S., Canada, the U.K., and Ireland.

Aside from its refining activities, Valero produces ethanol from corn, and renewable diesel made from biomass to be sold in premium low carbon markets in California, Canada, and Europe. Valero is heavily investing in producing sustainable forms of energy.

Recently Valero fully acquired Valero Energy Partners LP who owned, operated, developed and acquired crude oil and refined petroleum products pipelines, terminals, and other transportation and logistics assets and merged the partnership into its main holdings.

Valero was formerly known as Valero Refining and Marketing Company and changed its name to Valero Energy Corporation in August 1997. Valero Energy Corporation was founded in 1955 and is headquartered in San Antonio, Texas.

Source: Valero Investor Presentation February 2019

Refineries such as Valero produces many products from crude oil, including gasoline, kerosene, diesel, heating oil, aviation fuel, asphalt, and other by-products through its refinery process that is called “cracking.” For further information on this process, you can watch this YouTube film.

Financial Summary

Valero’s financial performance depends on what it pays for crude oil, the costs for refining, and at what prices it can sell its refined products, which is called the “crack spread” (a term used on the oil industry and futures trading for the difference between the price of crude oil and crude oil products extracted from it).

Through efficiently operating its refining process, Valero is operating at one of the lowest costs in the Industry compared to its peers, per barrel of throughput.

Valero Investor Presentation February 2019
  • Valero reported for the year ended 31 December 2018, an adjusted net income attributable to shareholders of $3.2 billion or $ 7.37 per share versus $2.2 billion or $4.96 per share for 2017.
  • Valero expects to invest $ 2.5 billion of capital in both 2019 and 2020, of which approximately 40% is for growth projects and 60% for sustaining the business. Valero keeps a 25% IRR as a hurdle rate for projects.
  • Valero is maintaining a debt to capital ratio between 20%-30% based on total debt reduced by $2 billion of cash
  • The company is dedicated to maintain an investment grade credit rating.
  • Valero has a commitment to shareholders to pay out a dividend of 40-50% of adjusted net cash. Note: the adjusted net cash from operating activities is calculated as net cash provided by operating activities excluding changes in working capital (i.e., current assets and current liabilities).
  • Valero has increased its dividend for the 9th consecutive year on January 24th with 12.5% to $ 0.90. This is a healthy dividend yield of 4.2% on current stock price that is at the high end of the peer group: PSX, MPC, HFC, and PBF.
  • Valero has a stock buyback program and has decreased its outstanding shares with 25% from 570 million shares in 2011 to 428 million shares in 2018.
Source: Valero Investor Presentation February 2019

Outlook

The world-wide demand for energy products, according to the US Energy Information Administration (EIA) is still growing and is expected to continue to do so.

Source: U.S. Energy Information Administration, International Energy Outlook 2017

According to the U.S. Energy Information Administration’s latest International Energy Outlook 2017 (IEO2017): “the EIA projects that world energy consumption will grow by 28% between 2015 and 2040”.

“Through 2040, the IEO2017 projects increased world consumption of marketed energy from all fuel sources, except for coal demand, which is projected to remain essentially flat. Renewables are expected to be the fastest-growing energy source, with consumption increasing by an average 2.3% per year between 2015 and 2040. The world’s second fastest-growing source of energy is projected to be nuclear power, with consumption increasing by 1.5% per year over that period.”

This outlook places Valero with its refinery products and renewable diesel well positioned in a growing energy market.

According to Valero’s investor presentation:

“product shortages in Latin America, Eastern Canada, Europe and Africa is expected to drive demand growth and Valero’s portfolio facilitates further global optimization of product exports.”

https://www.eia.gov/todayinenergy/detail.php?id=32912

Joe Gorder the President and CEO of Valero mentioned in the February 2019 press release: “We’re starting 2019 with relatively low oil prices and an economy that is growing, which should support demand for refined products.”

The market analysts currently expect a growth of 34.1% for Valero that could raise the EPS to $10 per share in 2019.

Valuation

Based on the 2018 EPS of $7.37 (2018) Valero is currently trading at a PE ratio of 11.42.

Given the analysts’ expectations for a 34.1% growth to an EPS of $10 per share (2019), the PE ratio at the current stock price is 8.75 which is at the median range considering the 5 Year Minimum and Maximum range between 6 and 12.

Hence, based on the 5 Year historic PE ratio, Valero stock is currently trading at fair value. The future stock price could well range between $52.5 and $105 per share given the minimum and maximum PE range in the past years. For your reference: the 52-week low was trading at $68.81 and the 52-week high was trading at $126.98.

Looking at the EBIT valuation, Valero trades between a 6 to 12 EBIT Multiple with, at the time of writing this article, a 15% margin of safety.

VLO: EBIT Valuation using online Old School Value Tools

Looking at other valuations one could argue the Valero stock could be trading at reasonable margin of safety based using the expected growth scenario and using the various OSV valuation methods on the OSV website:

VLO: Valuation as of Feb 15th using online Old School Value Tools

In my personal opinion the above mentioned median fair value of $142.85 is at the high end of the current fair value though. Looking at historic EBIT Valuation, VLO is currently trading at the low end of its fair valuation.

Risks

Valero’s financial performance is depending on what it pays for oil, the costs for refining and what at what prices it can sell its refined products.

Margin pressures can arise due to higher prices on crude oils, lower prices for refined products or from lower ethanol prices. If the economy will hit a recession this could well negatively affect the demand for refined products. Extreme weather events, rising sealevels and accidents can also negatively affect the operations and lower output of the refineries.

In the review of Climate-Related Risks and Opportunities report the company further mentions the following risks:

  • “Increasingly stringent fuel efficiency standards and increased adoption of electric vehicles could reduce consumer demand for liquid transportation fuels.”
  • Policies that seek to address climate risks, such as a carbon tax, cap and trade, and low-carbon fuel standards, could increase the cost of our products in affected regions
  • Potential climate litigation from governments and non-governmental climate organizations could increase our operating costs.”

Source: Valero’s Review of Climate-Related Risks and Opportunities

Are its dividends safe? Since May 1989, Valero paid a dividend each quarter. During the last big recession in 2010, the company lowered its dividend by 66% from $0.55 to $0.18. Since November 2011 the company has raised its dividend for 9 consecutive years.

Conclusion

The stock is currently trading at the low end of its fair valuation.

With a growth expectation of 34.1% on EPS, the current strong commitment of management to a dividend payout, stock buybacks and prudent financial management demonstrated this stock is worth considering to do more due diligence and is potentially a buy on weakness.

Whether this stock is suitable for you depends on your goals, objectives and risk tolerance of your portfolio. So, I urge you to do your own due diligence and seek expert financial advice.

Disclaimer

I am/we are long VLO. This post was written in mid-February 2019. I wrote this article myself (based on reliable sources and from press releases by Valero Corporation), and it expresses my own opinions. I am not receiving compensation for it (other than from Old School Value). I have no business relationship with any company whose stock is mentioned in this article.

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