2023-03-08 16:54:21 ET
Summary
- Energy stocks have pulled back from their highs, but stable oil prices may help some firms plan ahead.
- Refiners are highly dependent on crack spreads, and favorable pricing in this mid-cycle environment means big free cash flow potential.
- Valero shares are cheap on a P/E and FCF basis, along with management's focus on shareholder-friendly activities.
Amid remarkably high interest rate volatility and a VIX that hovers around 20, oil volatility is nothing to write home about at the moment. A trading range from the low $70s to low $80s on WTI frustrates energy investors as the days of triple-digit oil seem like a faint memory. A muted OVX is ideal, though, for capital allocation decisions among executives in the oil and gas space. With some stability at these levels, Energy sector firms are plenty profitable and generate strong free cash flow both upstream and downstream.
Valero Energy Corporation ( VLO ), a major domestic refiner, sports a low valuation and impressive earnings growth. I see the stock as a buy today but am carefully watching the charts for clues on momentum.
Oil Volatility Calming
According to Bank of America Global Research, Valero Energy Corp. is one of the largest independent petroleum refining and marketing companies in the United States. The company is based out of San Antonio, Texas, owns 13 refineries in the United States, Canada, and Europe, and has a total throughput capacity of around 2.5 million barrels per day.
The $50.8 billion market cap Oil, Gas & Consumable Fuels industry company within the Energy sector trades at a low 4.6 trailing 12-month GAAP price-to-earnings ratio and pays a solid 3.0% dividend yield, according to The Wall Street Journal.
The refiner has a diversified balance sheet, though it is of course leveraged highly to near-term sour oil markets domestically - a rise in oil without commensurate gains in refined products could crunch margins. There's exposure to the growing international natural gas market, however, that should promote long-term upside potential to earnings. Something to watch is total miles driven in the states - more gasoline to expand crack spreads and benefit VLO.
The mid-cycle environment means US refining margins may top 60%. That would lead to major free cash flow and further dividend increases along with share buybacks. That cash also helps to bring down the firm's net debt and reduce interest expenses if capital is allocated to debt repayments in this higher interest rate environment.
On valuation , analysts at BofA see earnings dropping this year after massive growth in 2022. Valero is positioned well in this mid-cycle energy period, which should support strong margins. While earnings may peak later this year and drop through 2024 and '25, per-share profits are seen as stabilizing in the low to mid-teens.
If we assign a below-market 14 multiple to $12 of EPS, then the stock should trade near $170. What's more, the current and forward EV/EBITDA ratio is at a significant discount to the market's average while shares trade at less than 10x free cash flow with dividends on the rise.
Valero: Earnings, Valuation, Free Cash Flow Forecasts
Value investors will like that VLO is currently one of the biggest positions in the Pacer US Cash Cows 100 ETF ( COWZ ).
COWZ: VLO A Top Holding
Looking ahead, corporate event data provided by Wall Street Horizon show an unconfirmed Q1 2023 earnings date of Thursday, April 27. A dividend pay date takes place next Thursday. With CERA week ongoing in Texas, the event risk calendar is light until earnings.
Corporate Event Risk Calendar
The Options Angle
Digging into the upcoming earnings report, data from Option Research & Technology Services (ORATS) show a 5.6% earnings-related stock price swing when analyzing the at-the-money straddle expiring soonest after the late-April earnings release. With a low VIX, calm OVX, and muted stock price moves around prior quarterly reports, I do not expect a large post-earnings share price move.
Seeking Alpha data show that the consensus earnings forecast is $6.70 on $39.4 billion in revenue. That compares with just $3.23 of per-share profits earned in the same quarter a year ago.
VLO: Muted Implied Volatility Relative to History, Strong EPS Beat Rate History
The Technical Take
With an attractive valuation and uneventful options pricing, a potentially bullish chart pattern is unfolding. Notice in the graph below that VLO continues to consolidate under key resistance in the $141 to $143 zone. The stock had abnormal price action associated with the poor NYSE open back on January 25, so I am tossing out that strange candlestick. But what did matter was some price action in the sessions that followed. Valero failed to build on its all-time highs when it touched near $150. A swift pullback on that false breakout back down to $126 ensued, but $142 was revisited in the days thereafter.
Now, I see support near $130 based on an uptrend line dating back to 2020. But should that level break, then a move to previous support around $96 could be in the cards. The 200-day moving average is modestly rising and could attract some trend-following buyers in the mid-$120s, too. Finally, volume has been on the decline lately as the consolidation ages - that's normal but watch for a breakout or breakdown on volume.
Overall, long here in the low $130s with a stop under $120 is a favorable risk/reward play, but also waiting for a bullish breakout above $150 could be a smart momentum trade.
VLO: Bullish Ascending Triangle Formation, Watching $150
The Bottom Line
I am a buy on Valero, but I am keeping a watch on the technicals. There's plenty of bullish sentiment in the oil refining space, though valuations and free cash flow metrics are robust.
For further details see:
Valero: This Free Cash Flow Cow Is Attractively Valued As Oil Prices Stabilize