VLO - Valero: Opportunity To Buy A Great Refinery At A Discount

2023-05-15 06:38:55 ET

Summary

• VLO's Q1 2023 profits rose significantly to $3.1 billion, up from $905 million the previous year, driven by strong performance in refining and renewable energy segments.
• VLO's Green Initiatives are advancing, with the Diamond Green Diesel joint venture reporting $205 million in operating income and the approval of a Sustainable Aviation Fuel project.
• VLO has strategically positioned itself in the global refining sector, which is undergoing transformation due to COVID-19 and a shift towards low-carbon futures.
• Despite a 19% reduction in VLO's share price, the investment thesis remains strong due to the company's robust infrastructure, adaptability, and promising growth in green energy.

Since the publication of my previous article , there's been a 19% decrease in Valero Energy Corporation's ( VLO ) share price. This downturn, I surmise, is largely due to fears of an impending economic recession. In this article, I'll dissect the latest earnings results, provide an updated analysis of VLO's standing within the sector, and review my target price for VLO shares. Despite the 19% reduction in stock value, my initial investment thesis remains unaltered, leading me to maintain my Buy rating for the shares. For a comprehensive understanding of my investment perspective on VLO, I highly recommend reviewing my initial investment thesis .

Good Q1 2023 Profits, Advances in Green Initiatives, and Strengthens Market Position

While revenues decreased 5.46% to $36.44 billion, VLO reported a significant rise in its first-quarter profits for 2023. Net income was $3.1 billion, or $8.29 per share, an impressive leap from the previous year's $905 million, or $2.21 per share.

The refining segment led the way with an operating income of $4.1 billion, a considerable increase from $1.5 billion in Q1 2022. The refineries operated at a 93% capacity utilization rate in the first quarter, even amidst planned maintenance at several facilities. The company's commitment to operational excellence remains evident in these figures.

On the renewable front, the Diamond Green Diesel (DGD) joint venture reported $205 million in operating income, a growth from $149 million in Q1 2022. This improvement was primarily due to additional volumes from the DGD Port Arthur plant's startup in the last quarter of 2022.

The Ethanol segment also showed promising growth, with a Q1 2023 operating income of $39 million, a considerable increase from $1 million in the first quarter of 2022.

VLO's financial prudence is reflected in its $199 million debt reduction and returning over $1.8 billion to stockholders through dividends and stock buybacks. The company also declared a regular quarterly cash dividend on common stock of $1.02 per share.

Strategically, VLO successfully completed the Port Arthur Coker project in March, which began operations in April. This project is expected to enhance the Port Arthur refinery's throughput capacity, enabling it to process more sour crude oils and residual feedstocks.

The company's green initiatives also took a leap forward with the approval of a Sustainable Aviation Fuel ((SAF)) project at the DGD Port Arthur plant. This project aims to upgrade around 50% of the plant's current renewable diesel production capacity to SAF. Once completed in 2025, DGD is expected to emerge as one of the world's largest SAF manufacturers.

In a significant development in the carbon sequestration space, Valero is collaborating with BlackRock and Navigator, with startup activities expected to begin in late 2024. The goal is to produce lower carbon-intensity ethanol and significantly enhance the margin profile and competitive positioning of its ethanol business.

How Valero Can Benefit from the Global Refining Sector's Transformation in the Post-Pandemic World

The global refining sector has been considerably impacted by the COVID-19 pandemic, leading to drastic shifts in supply and demand throughout 2020 and 2021. As per the IEA , worldwide oil markets are in the process of rebalancing post the unprecedented demand collapse of 2020 due to the pandemic. However, a complete return to pre-pandemic conditions may never materialize. The IEA's medium-term forecast suggests that the pandemic's swift behavioral changes, coupled with intensified governmental efforts towards a low-carbon future, have significantly lowered the projected oil demand for the coming six years.

This scenario has compelled oil-producing nations and companies into making challenging decisions, as they grapple with the dilemma of leaving resources untapped or introducing new capacity that might remain unused.

The refining sector is currently dealing with a surplus capacity, while the upstream sector may witness a reduction in its capacity buffer. The pandemic-induced demand shock, large-scale expansions, and anticipations of a long-term demand decline create an overhang that can only be eliminated through significant closures.

Currently, a third round of global refinery rationalization is in progress. Although shutdowns of 3.6 million barrels per day (mb/d) have been announced, a total closure of at least 6 mb/d is necessary to push utilization rates above 80%.

The refining activity growth till 2026 is expected to be dominated by operations east of Suez. Consequently, Asian crude oil imports could skyrocket to nearly 27 mb/d by 2026, calling for unprecedented levels of Middle Eastern crude oil exports and Atlantic Basin production to fill the void. The epicentre of refined products trade is also anticipated to shift towards Asia, pushing the region’s oil import dependence to 82% by 2026.

For VLO these shifts present unique opportunities. With its strong infrastructure and ability to adapt to changing market conditions, VLO is well-positioned to navigate this evolving landscape. As the demand for traditional petroleum products may decrease, the company's investments in renewable energy and low-carbon technologies could provide a competitive edge, catering to the growing demand for sustainable energy sources. The company's strategic geographic location could also help cater to the burgeoning demand in Asia, potentially boosting its market share and profitability in the long run. Lastly, I anticipate the closures of less profitable refineries, leaving well-positioned companies like VLO to remain operational and potentially increase their market share.

Updates Valuation

Updated my assumptions based on the Q1 results, the target value for VLO remains at $189 per share. While I reduced the revenue expectations for 2023 and 2024 based on the crack spread futures , that decrease was offset by the 2.6% reduction in outstanding shares down from 371 million shares to 361 million shares. Below are my main assumptions:

Conclusion

Despite global shifts in the refining sector and a transitioning energy landscape, VLO is well-positioned for future growth. Its robust infrastructure, adaptability, and strategic initiatives, particularly in green energy, offer a promising outlook. The company's strong Q1 2023 performance further bolsters this potential. Consequently, I maintain a Buy rating for VLO's shares with a steady target price of $189. This is despite minor adjustments in revenue expectations for 2023 and 2024, counterbalanced by a reduction in outstanding shares. I recommend reviewing my initial analysis for a detailed perspective on VLO's investment potential.

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