A little over a month ago, I wrote about the value proposition for Valero Energy Corp. (VLO). The stock is only a bit above its price at that time, but with a new set of quarterly earnings information, it has a somewhat different fundamental profile. A month or so isn’t a lot of time, but it is long enough to see a lot of different aspects of the broad economic and geopolitical landscape change. Oil prices, for example have increased a little less than 10% in that short period of time. Demand has been healthy, supported by increasing U.S. shale production even as OPEC continues to pump below its quota levels. That has kept the spread between West Texas Intermediate (WTI) and Brent crude consistently between $8 and $10 per barrel, which is generally a positive for U.S. producers and refiners, and most analysts expect oil prices to increase to around $70 by 2020. That should also be a net positive.
VLO is a good example of the kind of fundamentally solid refining stock that I think is in a pretty good position for growth. Since hitting a high around $127 in June of last year, the stock dropped more than 50% at the the end year to a low around $69. From that point, the stock has rebounded nicely to its current level, but still remains more than 35% below that peak price. This is an oil refining company that pays a dividend that translates to an income yield of more than 4% at its current price. It’s true that when you buy a stock – even a dividend-paying stock – you have to also accept the fact that the stock is going to fluctuate in price; but having an annual yield a bit above 4% to work with makes working with that reality a lot easier, especially if the rest of the stock’s fundamentals are strong.
The real question right now, of course is whether the stock’s current price still represents a good value. The company’s fundamental profile is a bit different than it was a month ago, and that means that the usefulness of its value proposition may also have shifted. Is it enough to prompt you to shy away from the stock? Take a look and decide for yourself.
Fundamental and Value Profile
Valero Energy Corporation (Valero) is an independent petroleum refiner and ethanol producer. The Company’s segments include refining, ethanol and Valero Energy Partners LP (VLP). The refining segment includes its refining operations and the associated marketing activities. The ethanol segment includes its ethanol operations and the associated marketing activities, and logistics assets that support its ethanol operations. The Company owns logistics assets (crude oil pipelines, refined petroleum product pipelines, terminals, tanks, marine docks, truck rack bays and other assets) that support its refining operations. Some of these assets are owned by VLP, which is a midstream master limited partnership owned by the Company. VLP’s assets include crude oil and refined petroleum products pipeline and terminal systems in the United States Gulf Coast and the United States Mid-Continent regions. Its refineries produce conventional gasolines, premium gasolines and lubricants, among others.VLO’s current market cap is $34.9 billion.
Earnings and Sales Growth: Over the last twelve months, earnings and sales both grew, with earnings increasing nearly 83%, and sales growing just under 9%. Growing earnings faster than sales is hard to do, and generally isn’t sustainable in the long term; but it can also be a positive mark of management’s ability to maximize their business operations. The company operates with a narrow margin profile; over the last twelve months, Net Income was 2.66% of Revenues over the past year; however it did increase in the last quarter to about 3.33%. These are pretty tight numbers, to be sure, but this does seem to be a normal part of the way VLO does business.
Dividend Yield: the stock pays a yearly dividend of $3.60 per share, which translates to an annual dividend of around 4.25%.
Free Cash Flow: VLO’s free cash flow is pretty healthy given their narrow operating margins, at $2.6 billion. That translates to a Free Cash Flow Yield of 7.4%. It should be noted that Free Cash Flow has dropped since January 2018, when it was a little over $4 billion.
Debt to Equity: VLO has a debt/equity ratio of .39. This is a low number that generally suggests debt management shouldn’t be a problem. The company’s balance sheet shows about $3 billion in cash and liquid assets against about $8.8 billion in long-term debt. Consistent with its pattern of declining Free Cash Flow, cash was about $5.85 billion at the beginning of 2018, which means not only that the company is dealing with deteriorating cash flow but also declining liquidity. That is a red flag that bears watching.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for VLO is $54.43 per share, and which translates to a Price/Book ratio of 1.57. Their average Price/Book Value ratio is 1.625, which means the stock is pretty fairly valued, and is only about 3.47% below that “fair value” measurement. By contrast, however, the stock is trading more than 17% below its historical Price/Cash Flow average. That puts a long-term “fair value” price for the stock somewhere around $100.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above shows the last year’s worth of price movement for VLO. The stock’s rally from its December downward trend low is impressive by itself, but since that point the stock has begun to establish a clear consolidation pattern with immediate support around $82 and resistance around $87. A break above $87 would mark a resumption of the short-term upward trend that started at the end of 2018, with room to run in the short-term to around $91 per share, around the 38.2% retracement line and about $97 where the 50% retracement line sits. A drop below support, to $81 could see the stock keep dropping to the trend low around $69.
Near-term Keys: There could be a useful, short-term, momentum-based opportunity with VLO on the bullish side, assuming it breaks above the $87 pivot high point I just mentioned. That would be an excellent signal for a bullish, momentum-based trade, by either buying the stock outright or working with call options with an eye on $91 as a near-term target. If the stock pushes below support at around $81, there could be a good short-term opportunity to short the stock or work with put options with an eye on $77 as an immediate target or $69 if bearish momentum accelerates. Based strictly on Book Value, the stock would need to drop to about $70 to offer a compelling value, but if you don’t mind working with the Price/Cash Flow ratio, it is actually quite attractive. Given the generally bullish forecast for the oil industry and the entire energy sector into the next year I think it’s a smart idea to pay attention to VLO right now.