We maintained our recommendation for Valero Energy Corporation (VLO) at Neutral on Nov 29, 2013. Valero’s string of growth projects and operational improvement will likely drive free cash flow in 2013. However, we remain on the sidelines considering risks such as natural disasters, unplanned plant disruptions and alterations in environmental regulations. 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 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 one-half of its needs.
Valero spun off 80% stake from 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. The remaining 20% was divested by the company on Nov 14, 2013. We feel the move would help the company to concentrate on its industry-specific strategies.
Management’s commentary regarding a master limited partnership (MLP) opportunity is a positive. Valero filed an S-1 for a logistics MLP, Valero Energy Partners LP (VLP), in September. The MLP will not only enable Valero to monetize its existing infrastructure, but is also likely to offer a favorable financing option for future logistics projects, which would then be included in the partnership.
Valero remains optimistic on the ongoing economic growth projects. These projects are expected to drive significant improvement in earnings in the future. The company also replaced all imported light sweet crude oil used at its Gulf Coast and Memphis, Tennessee, refineries with cheaper North American crude oil recently.
However, Valero’s earnings decreased 70% in the third quarter of 2013 from the prior-year quarter. Lower refining throughput margins in each of the company’s regions and higher refining operating expenses affected the results. 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 Stocks to Consider
While we prefer to remain on the sidelines for Diamond, Zacks Ranked #1 (Strong Buy) stocks – SM Energy Co. (SM), Western Gas Partners LP (WES) and Abraxas Petroleum Corp. (AXAS) – could be good buying options for the short term.
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