VLO - Vectoring In On Valero Energy

2023-07-24 08:45:05 ET

Summary

• Today, we put the largest North American refiner, Valero Energy, in the spotlight.
• The shares appear cheap on some valuation metrics and also pay better than a three percent dividend yield.
• The stock has been range bound, setting up a potential covered call trade. An investment analysis follows below.

Only the self-sufficient stand alone - most people follow the crowd and imitate ." - Bruce Lee

Today, we put Valero Energy Corp. ( VLO ) , North America's largest refiner, in the spotlight. The company is due to report second quarter results over the next week, and the stock appears cheap via some valuation metrics. The stock also pays a 3.3% dividend yield. As you can see below, the shares have been mostly rangebound over the past year, which might set up the equity as a solid covered call trade. An analysis follows below.

Company Overview:

Valero Energy as mentioned above is North American largest refiner and operates numerous refineries that produce gasoline, distillate, jet fuel, and a variety of other products. The company also owns and operates crude oil and refined petroleum products pipelines, terminals, tanks, marine docks, truck rack bays, and other logistics assets. The stock currently trades just above $122.00 a share and sports a market capitalization of just south of $45 billion.

First Quarter Results:

On April 27th, Valero posted its first quarter results . The refiner had non-GAAP earnings of $8.27 a share, more than $1.75 a share above expectations. Revenues fell just over five percent on a year-over-year basis to $36.44 billion, just over $1 billion light of the consensus.

Net cash provided by operating activities in the first quarter was $3.2 billion. The company's core refining segment reported net income of $4.1 billion in the quarter. This is up sharply from the $1.5 billion in net operating income in the same period a year ago as the company operating at 93% of capacity during the quarter.

The company's much smaller Renewable Diesel segment through a joint venture recorded $205 million in net income, up nicely from $149 million in 1Q2022.

Analyst Commentary & Balance Sheet:

The analyst community is generally positive on Valero. Since mid-May, eight analyst firms including RBC Capital, JPMorgan, and Morgan Stanley have reiterated Buy/Outperform ratings on VLO. Goldman Sachs has maintained its Sell rating and $113 price target while Wells Fargo reissued its Hold rating and $120 price target.

Less than three percent of the outstanding float in the shares is currently short. There has been no insider activity (either selling or buying) in the stock so far in 2023. After reducing debt by nearly $200 million during the quarter, Valero had $9 billion of total debt, $2.4 billion of finance lease obligations, and $5.5 billion of cash and cash equivalents on its balance sheet. The company paid out $379 million worth of dividends in the first quarter and bought back $1.5 billion worth of stock (just over three percent of the outstanding float). The company's balance sheet is in great shape with a debt to capitalization ratio, net of cash and cash equivalents, of just 18 percent at the end of the first quarter

Verdict:

Valero made $29.16 a share of profit in FY2022 on just over $176 billion in revenues. The analyst firm consensus sees dropping 19% in FY2022, thanks largely to lower energy prices and EPS declining to just over $21.00 a share. In FY2024, they see earnings of just over $13.00 as sales fall again in the low teens.

It should be noted an investor should take FY2024 estimates with a large grain of salt as much will be dependent on how the economy is doing as well as where oil costs are next year. With FY2022 actual results and FY2023 estimates, VLO trades just over four times trailing earnings and six times forward earnings. Competitor Phillips 66 ( PSX ) trades at just over five times trailing earnings and nine times forward earnings in way of comparison.

Despite the hyperbole about a paradigm shift to alternative energy vehicles, the demand for gasoline and other refined products is going to be here for a long time. In addition, there is somewhat of a moat on refinery assets, as the U.S. has not built a large new refinery since Jimmy Carter was in office. Therefore, I like the longer-term value on VLO and the equity pays a nice dividend to boot.

When I have a stock I think has value and I don't mind owning it, but it is in a trading range, I love a covered call strategy. This provides some downside risk mitigation and can provide a nice overall yield. Here is how I am playing VLO at these trading levels.

Option Strategy:

Here is how I would establish a holding in VLO utilizing a covered call strategy. Selecting the January $120 call strikes, fashion a covered call order with a net debit in the $109.80 to $110.20 a share range (net stock price - option premium). This strategy provides downside protection of 12%. This strategy also has nearly an 11% potential upside even if the stock drifts down a little over the next six months, including the two quarterly dividend payouts that will be received. Not a sexy strategy, but a prudent one in this uncertain market.

Most people spend their lives vulnerable, relying on the rest of the world to not take advantage of it. " - Kris Rafferty

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