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Valero Still Stays Neutral

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We maintain our Neutral recommendation on Valero Energy Corporation (VLO - Free Report) – the largest independent refiner and marketer of petroleum products in the U.S.

The company’s diversified refinery base, better-than-expected second quarter results as well as its string of growth projects are somewhat tempered by the risks that include government regulations, fluctuations in refining capacity utilization and weather conditions.

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. It remains 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 posted impressive second quarter results mainly buoyed by higher throughput margins in the U.S. Mid-Continent, U.S. West Coast and North Atlantic. Further, the addition of the Pembroke and Meraux refineries increased the refinery throughput volume by 342,000 barrels per day.

San Antonio, Texas-based refiner has stepped up its investment level to reap the benefits from the current high trend of oil price and timid gas price environment. It increased its 2012 capex budget to $3.6 billion from the prior expectation of $3.5 billion.  

Most of the projects are expected to get completed by year-end and will likely drive a significant improvement in earnings in 2013. Major capital investment, particularly the hydrocracker units at Port Arthur and St. Charles this year, should be a key driver for future growth, beginning in 2013. These projects position Valero to increase diesel production and diversify its market exposure.

However, it plans to reduce the capex budget to a band of $2.0–$2.5 billion for the next year after major project completions this year. The close of the ongoing projects would mark the end of a series of major expansion programs and will likely increase free cash flow. The incremental cash flow will provide the company with additional financial flexibility and increase shareholder value.

In this regard, it is worth mentioning that Valero announced its plan to separate its retail arm from the company, likely through a tax-advantaged distribution to shareholders to unlock value. It remains hopeful that the move would help it to concentrate on its industry-specific strategies. Again, the company raised its quarterly dividend to 17.5 cents per share from 15 cents a share, reflecting an increase of 17%. These actions clearly reveal Valero’s focus on increasing long-term shareholder value.

However, being the largest independent refiner in the country, Valero remains particularly susceptible to the ongoing unfavorable macro backdrop. For example, in Europe, Valero remains exposed to the difficult economic environment and deceleration of the capacity rationalization process. Additionally, risks like natural disasters, unplanned plant disruptions and alterations in environmental regulations also remain our concerns.

Hence, considering the pros and cons, we see the Valero stock performing in line with its peers like Sunoco Inc (SUN - Free Report) . The stock retains a Zacks #2 Rank (short-term Buy rating).

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