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We upgraded our recommendation on Valero Energy Corporation (VLO - Analyst Report), the largest independent refiner and marketer of petroleum products in the U.S., to Neutral from Underperform, on Sep 17, 2013. Valero carries a Zacks Rank #3 (Hold).

Why Maintained?

Among all the independent refiners, Valero offers the most diversified refinery base with a capacity of 3.0 million barrels per day in its 16 refineries located throughout the U.S., Canada and the Caribbean. More importantly, Valero is best positioned to profit from increased refining margins mainly on account of its strategic refinery structure that enables it to use cheaper oil for over half of its needs.

Valero spun off 80% stake of its retail arm – CST Brands Inc. – through a tax-advantaged distribution to shareholders, to unlock value on May 1, 2013. The spin-off of the company's retail arm generated an immediate net cash benefit of $500 million, after shelling out $220 million in taxes. We feel the move would help the company to concentrate on its industry-specific strategies. Also, Valero plans to sell out the remaining 20% stake over the next 18 months, which will infuse more liquidity into its books.

Valero remains optimistic on its ongoing economic growth projects. It already has several new projects, such as the Parkway Pipeline project with Kinder Morgan Energy Partners LP, with start-up scheduled for mid-2013 and the recently completed Diamond Green Diesel joint venture biofuels plant. The company also commenced operations from its new hydrocracker at St. Charles refinery that will enhance production. These projects are expected to drive a significant improvement in earnings in 2013. The company also recently replaced all imported light sweet crude oil used at its Gulf Coast and Memphis, Tennessee, refineries with cheaper North American crude oil.

However, Valero’s earnings decreased 4.3% in the second quarter of 2013 from the prior-year quarter. Lower refining throughput margins in each of the company’s regions and higher refining operating expenses adversely impacted the results.

Other Stocks to Consider

While we prefer to remain on the sidelines for Valero, Zacks Ranked #1 (Strong Buy) stocks – China Petroleum & Chemical Corp. (SNP - Analyst Report), Stone Energy Corp. (SGY - Analyst Report) and Dril-Quip Inc. (DRQ - Analyst Report) – could be good buying options for the short term.

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