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We reaffirmed our Neutral recommendation on the largest North American independent refiner and marketer of petroleum products Valero Energy Corporation (VLO - Analyst Report), on May 14, 2013. Riding on growth in refining throughput margins, the company reported robust earnings in the first quarter. The company currently holds a Zacks Rank #3, which is equivalent to a short-term Hold rating.

Why Maintained?

Texas-based Valero Energy offers the most diversified refinery base among all the independent refiners, with a capacity of 3 million barrels per day in its 16 refineries located throughout the U.S., Canada and the Caribbean.

Valero’s stable performance in the first quarter can be traced back to favorable refining margins and lower operating expenses.

With $1.9 billion in cash at the end of the quarter, we think the company certainly has the financial flexibility to make aggressive purchases, thereby expanding its refining footprint.

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 one-half of its needs.

Valero recently spun off 80% stake of its retail arm – CST Brands Inc. (CST - Snapshot Report) – 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, the company plans to sell out the remaining 20% stake over the next 18 months which will infuse more liquidity in the books of the company.

However, being the largest independent refiner in the country, Valero remains exposed to the ongoing tepid macro backdrop. Refiners in the U.S. generally face uncertainty regarding future regulations pertaining to greenhouse gas emissions and the potential for higher requirement of biofuels. Other threats include government regulations, weather conditions, crude oil and natural gas prices as well as renewable fuel prices. These can result in increased costs, reduced growth and fines or other sanctions.

Other Stocks to Consider

There are other stocks in the sector that however appear more rewarding. These include Enerplus Corporation (ERF - Snapshot Report) and Hydrogenics Corporation (HYGS - Snapshot Report), which are expected to perform impressively over the next few months and carry a Zacks Rank #1 (Strong Buy).
 

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