Summary
- Valero Energy enjoyed amazingly profitable times during 2022 as refining margins reached never-before-seen levels.
- This saw their operating cash flow equal their results of the last three years combined, which helped achieve their deleveraging target.
- Even though management speaks positively about 2023, they only increased their dividends by a meager 4%.
- This is disappointing as their outstanding share count is down around 8% in the last year alone, thereby effectively making for a stealth dividend cut as their payments fall lower.
- This calls into question their commitment to rewarding shareholders and thus, I now believe that downgrading to a sell rating is appropriate.
Introduction
Following Valero Energy ( VLO ) seeing a bumpy but ultimately profitable ride during 2022, it seemed as though 2023 will be a story of Russia versus the economy, as my previous article discussed earlier in the year. Fast forward to the recent release of their fourth quarter of 2022 results and years of waiting for dividend growth to return, their booming financial performance only gave rise to a meager 4% dividend increase that effectively equals a stealth dividend cut, thereby disappointingly tarnishing the appeal of the shares.
Coverage Summary & Ratings
Since many readers are likely short on time, the table below provides a brief summary and ratings for the primary criteria assessed. If interested, this Google Document provides information regarding my rating system and importantly, links to my library of equivalent analyses that share a comparable approach to enhance cross-investment comparability.
Author
Detailed Analysis
Despite operating conditions easing during the third quarter of 2022 versus the second quarter, their cash flow performance continued to see massive results during the fourth quarter. This ultimately saw 2022 close out the books with operating cash flow at a never-before-seen $12.574b that easily eclipsed their previous result of $5.859b during 2021. In fact, even aggregating all of their results for 2019, 2020 and 2021 together, only produces a result of $12.338b and thus, 2022 was effectively three years all wrapped into one.
When viewing their operating cash flow on a quarterly basis, it shows the fourth quarter of 2022 by itself saw a reported result of $4.096b that almost equals what they normally generate on an annual basis, which is truly amazing and speaks to the rarity of these booming operating conditions. Even better, it was fundamental and not merely due to working capital movements, as their underlying result that excludes such movements was actually slightly higher at $4.105b.
Quite unsurprisingly, this massive operating cash flow also helped propel their free cash flow higher to see 2022 lock in a result of $9.935b, thereby up from $6.479b following the first nine months. Going forwards into 2023, their operating cash flow is impossible to predict given the inherent volatility of their industry but thankfully, their capital expenditure is posed to decrease modestly, as per the commentary from management included below.
"Turning to guidance. We expect capital investments attributable to Valero for 2023 to be approximately $2 billion, which includes expenditures for turnarounds, catalysts and joint venture investments."
-Valero Energy Q4 2022 Conference Call.
Throughout 2022, their capital expenditure was $2.738b and thus because their guidance for 2023 of circa $2b is modestly lower, it will help support free cash flow, regardless of the prevailing operating conditions. When conducting the previous analysis, I noted how 2023 was shaping up as a story of Russia versus the economy as upcoming sanctions on the former effectively fight against a gloomy economic outlook. Whilst I stand by this mixed outlook, it seems those running the company are remaining positive, as per the commentary from management included below.
"Looking ahead, we expect low product inventories and continued increase in product demand to support margins, particularly for US coastal refiners that have crude oil supply and natural gas advantages relative to global refineries. And we continue to see large discounts for heavy sour crude oils and fuel oils that we can process in our system."
-Valero Energy Q4 2022 Conference Call (previously linked) .
Ultimately only time will tell whether 2023 is another amazing year, a disappointment or somewhere in between. That said, the positive outlook from management further builds upon their lower capital expenditure guidance and amazing cash flow performance that facilitated reaching their deleveraging target, as subsequently discussed.
When these variables are combined, it makes for possibly the strongest base ever to see dividend growth. Although disappointingly, after years of waiting they only lifted their quarterly dividends by circa 4% to $1.02 per share versus their previous level of $0.98 per share. Even though more cash in the pockets of shareholders is positive, even on the surface this is lackluster because their dividend payments have not historically been burdensome nor oversized and more so, they just reached their deleveraging target after a record-setting year.
When digger deeper, the disappointment only grows because in my eyes, this is effectively a stealth dividend cut. Apart from failing to keep up with inflation running around the circa 8% mark lately, it also failed to even keep pace with their declining outstanding share count on the back of their share buybacks. As per their 2021 10-K , they ended 2021 with an outstanding share count of 409,195,638 and whilst the exact number ending 2022 is not presently known as we are still awaiting their 2022 10-K, their Q4 2022 8-K states the fourth quarter had a weighted average outstanding share count of 380,000,000. Even if utilizing this data point, it sees a decline slightly over 7% but as their outstanding share count was declining throughout the quarter, it stands to reason its number at the end of the year is below this point, thereby indicating somewhere around an 8% decline, give or take a little.
So in reality, it appears they could have actually increased their dividends broadly in line with inflation but instead, they only elected for a meager 4% increase that means 2023 will see lower dividend payments than 2022. I can understand and respect management not wanting to push their dividends too high but at the same time, this is effectively a stealth dividend cut given the declining size of their dividend payments in 2023 versus 2022. In my eyes, their dividends on a per-share basis should at least scale accordingly with the decline of their outstanding share count, especially as their share buybacks during 2023 will see their outstanding share count decline even further as more quarters pass. Interestingly, they were asked about this topic during their fourth quarter of 2022 conference call but alas, little insight was given with only a very generalized response, as per the commentary from management included below.
"So, we continue to aim for a dividend as sustainable and competitive versus our peers. We would also like to show growth."
-Valero Energy Q4 2022 Conference Call (previously linked) .
To be blunt, their response was not particularly helpful regarding their dividends nor explained why their dividend growth was only around half the extent their outstanding share count declined. As a result, it tarnishes the appeal of their shares and personally, it leaves me questioning their commitment to rewarding shareholders with tangible cash returns. If anything, their near-record-high share price should decrease the appeal of share buybacks versus dividends, especially given the cyclical nature of their industry that increases the risk of these share buybacks being conducted at less opportune times.
Following the fourth quarter of 2022 once again enjoying massive free cash flow, their net debt kept heading south, thereby ending the year at $6.773b and thus down a solid near 11% versus as recently as the third quarter, which ended at $7.607b. This now sees their net debt at the lowest point in recent history since at least the end of 2019 before the Covid-19 pandemic when it was $7.089b and thus achieving their deleveraging target, as per the commentary from management included below.
"And as you know, during COVID, we had to take on another $4 billion of debt in 2020. So, one of our main objectives as the financial situations improve post-COVID was the payback this incremental debt…"
"On the financial side, we continue to strengthen our balance sheet, paying off all of the incremental debt incurred during the pandemic and ending the year with a net debt to-capitalization ratio of 21%."
-Valero Energy Q4 2022 Conference Call (previously linked) .
Going forwards, it stands to reason their shareholder returns should continue scaling higher as their net debt decreases, relative to their free cash flow. At the moment, it would be redundant to reassess their leverage, debt serviceability or liquidity in detail as there were only modest changes to their capital structure since conducting the previous analysis following the third quarter of 2022.
The three relevant graphs are still included below to provide context for any new readers, which to absolutely no surprise, shows their leverage is once again very low with both their respective net debt-to-EBITDA and net debt-to-operating cash flow of 0.37 and 0.54 beneath the applicable threshold of 1.00. It also shows their debt serviceability is once again perfect with interest coverage of 28.03 and 27.37 when compared against their respective EBIT and operating cash flow. Obviously, their liquidity also remained strong once again with respective current and cash ratios of 1.38 and 0.28. If interested in further details regarding these topics, please refer to my previously linked article.
Conclusion
Following an amazingly profitable year throughout 2022, it was disappointing to see dividend growth of merely half the extent their outstanding share count declined, thereby effectively making for a stealth dividend cut as their 2023 payments will shrink versus 2022. This leaves questions regarding their commitment to rewarding shareholders, as they clearly have the financial firepower for much better dividend growth, especially after slashing their net debt to the lowest point in years. When combined with the mixed outlook discussed within my previous analysis and their historically elevated share price, I now believe that downgrading to a sell rating is appropriate.
Notes: Unless specified otherwise, all figures in this article were taken from Valero Energy's SEC Filings , all calculated figures were performed by the author.
For further details see:
Valero Energy: A Stealth Dividend Cut