VLO - Valero Has Strong Refining Growth Potential

2023-07-25 12:28:06 ET

Summary

• Valero Energy Corporation is focused on both an incredibly strong core business with substantial value-add, along with a growing renewable business.
• The company has more than 3 million barrels/day in its core business, generating incredibly strong margins in the most recent quarter.
• The company has a long history of shareholder returns in a variety of scenarios, and we expect that to continue, given the company's manageable debt load.
• Overall, Valero Energy Corporation is a valuable investment with strong potential.

Valero Energy Corporation ( VLO ) is one of the largest refining companies, with an almost $50 billion valuation. The company has seen its share price drop almost 20% from its 52-week highs, as refining margins have declined substantially. As we'll see throughout this article, Valero has the ability to continue driving substantial shareholder returns.

Valero's Q1 2023 Earnings

Valero achieved strong earnings in the first quarter, and we expect continued strength in earnings, when it soon announces its Q2 earnings ( expected Thursday, July 27).

The company earned $3.1 billion in net income for the quarter, with $8.3/share attributable. That gives the company a single-digit P/E and helps to show its financial strength. The company declared its more than 3% dividend yield and managed to return $1.8 billion to stockholders through dividends and share buybacks.

That represents comfortable shareholder returns of more than 30%, helping to show the company's financial strength and ability to drive strong returns when times are good. The company's manageable financial picture allows it to direct most earnings to shareholder returns.

Valero's Strategic Targets

The company has an impressive portfolio of assets, and its strategic targets involve both strong margins and reorienting its portfolio for lower margins.

The company has 15 refineries that it uses to move 3.2 million barrels/day of oil with substantial complexity. That forms the core of the company's portfolio, with the complexity offering a substantial value-add for the company. The company does also have substantial low-carbon projects that it's working to build up.

The company has 1.2 billion gallons/year of renewable diesel in production, equivalent to roughly 100 thousand barrels/day in renewable diesel production. The company is also working on new ethanol plans, and we expect its overall renewable efficiency to continue. As long as the company can make these renewable fuels, it'll help its long-term staying power.

Valero's Margins

The company is taking these assets and continuing to invest heavily with 40-50% of its capital in low-carbon projects.

The company's 5-year average is $1.4 billion in sustaining capital and $0.8 billion in growth capital. That's $2.2 billion in annualized capital spending, roughly. The company's 2023E target is $2 billion, with a bump in sustaining capital and a decrease in growth capital. That sustaining capital is the number that actually matters.

The lower the company can keep that the better. Growth capital investments for the long run have strong IRR targets that make them economic (normally) as an additional use of capital.

Valero's Liquidity

Valero has an incredibly strong financial position. The company paid off $200 million in debt for the quarter and has $9 billion in total debt, with $5.5 billion in cash and cash equivalents. That's a minimal net debt position, especially with an almost $45 billion market capitalization, and shows that the company can comfortably direct its earnings to shareholder returns.

We expect the company to direct the vast majority of its profits going forward toward shareholder returns.

Valero's Shareholder Returns

Putting all of this together, Valero is focused on generating strong shareholder returns.

The company managed to generate a record-breaking $6.1 billion in shareholder returns in 2022. The majority of that came from buybacks. The company has managed to reduce its share count by ~35% over the last several years, and over the past year, it managed to reduce its share price by almost 10%.

The company's dividend yield is more than 3%, one that it can comfortably provide going forward, but its reducing share count will help it much more for the long run.

Thesis Risk

The largest risk to our thesis is refining margins. Valero is focused on strong and continued efficiency in its portfolio. However, the company still can't control the supply and demand of margins for the commodity, and the industry is tough. Assuming margins turn down, that could hurt the company's ability to continue driving shareholder returns.

Conclusion

Valero Energy Corporation has an impressive portfolio of assets. The company's complex refining assets help set it apart from the rest and enable the company to continue generating high-margin earnings. The company generated incredibly high profits in 2022, which it managed to use for both strong dividends and shareholder returns.

The company managed to reduce its outstanding shares by almost 10% last year. That lets it turn its strong year into strong long-term returns for shareholders. We expect the company to continue that performance for the long run, in a variety of environments, making it a valuable investment. Let us know your thoughts in the comments below.

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