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Valero or Phillips 66: Which is a Better Pick for 2018?

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Toward the end of 2017, we saw partial recovery in oil prices. Solid demand growth, declining inventories and the extension of OPEC-led supply cuts until the end of 2018 is keeping the market steady and supporting strong uptrend.

While there might be a number of winners within the energy sector, refiners have stood out amid weakness in the commodity prices. Moreover, the overhaul of the nation’s tax code is expected to benefit the refiners. With the implementation of the law, the corporate income tax will be lowered from 35% to 21%, which will benefit the refiners.

This is because unlike crude producers and equipment makers who have been victims of stubborn low oil price environment and struggled to generate positive cash flows, refiners have been among the handful of energy sub industries displaying strength during the shaky period.

The business of downstream players is negatively correlated with crude prices. This is because the companies use oil as an input from which they derive refined petroleum products like gasoline, the prime transportation fuel in the United States. Hence, lower the oil price, higher will be their profits. Therefore, the income from converting crude into gasoline and diesel — also known as refining margin or crack spread — has been going up over the past few quarters.

Consequently, these companies — having generated positive income before taxes — are in a much better shape to take advantage of the current situation. Consequently, shares of the major downstream operators have been rising lately.
    
In this context, we put the spotlight on two of the refining players — Phillips 66 (PSX - Free Report) and Valero Energy Corporation (VLO - Free Report) — with market caps of $50.92 billion and $38.28 billion, respectively. Since both stocks currently carry a Zacks Rank #3 (Hold), it will be interesting to see which stock is better positioned in terms of fundamentals.

Valero Beats on the Bourses

Over the past year, Valero surpassed the industry’s gain of 22.6% as well as S&P 500 index’s rally of 21.3%. Moreover, Valero’s rise of 40.4% has outshined Phillips 66’s returns of 20.3%.

Valuation

Phillips 66 and Valero have P/E ratios of 29.4 and 20.3, respectively. Clearly, Valero is the cheaper proposition. Notably, while Valero is underpriced, Phillips 66 is overpriced compared with the industry’s P/E ratio of 25.4.

Liquidity

The liquidity of a company is determined through quick ratio which is a more stringent test to measure the capability of a company to pay both short- and long-term obligations.

Valero has a better liquidity than the industry’s level of 1.02 and that of Phillips 66’s 0.86. Valero’s quick ratio of 1.24 puts it in a more comfortable position to meet short-term obligations.

Return on Capital (ROC)

Coming to Phillips 66 and Valero, ROC for the trailing 12-months is 5.4% and 7.1%, respectively, which are above the sector’s level of 5.3%.

Last Quarter Performance & Projections

Phillips 66 delivered impressive results in third-quarter 2017 wherein adjusted earnings per share not only surged 58.1% year over year to $1.66 but also beat the Zacks Consensus Estimate of $1.62. Phillips 66 expects year-over year earnings growth of 60.28% and 39.39% in 2017 and 2018, respectively.

Valero’s third-quarter fiscal 2017 earnings surged over54% year over year to $1.91 per share, also surpassing the Zacks Consensus Estimate of $1.83. Valero expects year-over year growth of 34.41% and 29.68% in its earnings in 2017 and 2018, respectively.

In terms of long-term growth expectations, Phillips 66 scores above Valero. The expected growth rate for Phillips 66 for the next 3-5 years is 10.00% compared with an expected growth of 9.86% for Valero.

Earnings Surprise History

Considering a more comprehensive earnings history, Phillips 66 seems to be a clear winner. Phillips 66 delivered average positive earnings surprise of 429.3% in the trailing four quarters. However, the Valero reported average negative earnings surprise of 10.3% in the same period.

Dividend Yield

Ina year, the dividend yield for both Valero and Phillips 66 has been higher than the broader sector. While the sector depicted yield of 2.6%, Valero returned almost 3%. Phillips 66 has a dividend yield of 2.7%.

Cash Flow From Operations

Over the last nine months, Phillips 66 reported a sharp year-over-year decline in cash flow from operating activities, which is a key metric to gauge the financial health of the firms. Valero’s figure was unchanged. Valero generated enough cash to fund capital payment.

Phillips 66 generated operating cash flow of $1717 million in the first nine months of 2017 compared with $2296 million reported in the corresponding period of 2016. Valero generated cash flow from operations of $3822 million, unchanged from the corresponding period of 2016.

Bottom Line

Our comparative analysis shows that Valero has an edge over Phillips 66 considering price performance, valuation, liquidity, dividend yield.  Phillips 66 scores on long-term projections and earnings surprise history. On overall comparison, the scale is slightly tilted in favor of Valero.

However, we prefer to be on the sidelines and ask investors to hold the stocks for now, reflected by the companies’ Zacks Rank.

A few better-ranked stocks in the same industry are Statoil ASA and Pioneer Natural Resources Company (PXD - Free Report) . Both these stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

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