EUR 850.00 For Business Accounts Only

Morningstar | Increasing Valero FVE, Although Shares Still a Bit Pricey; Conditions Look to Remain Favorable

Valero Energy's second-quarter adjusted earnings soared to $928 million from $548 million the year before as the company effectively capitalized on favorable market conditions despite lower volumes. Refining operating income increased to $1.4 billion from $945 million the year before thanks to higher distillate margins and wider sour and domestic light sweet crude discounts, which offset slightly lower throughput volumes due to turnarounds and a fire in the Texas City refinery in April. Management noted past investments in light crude processing capacity and transportation infrastructure, notably the Diamond Pipeline, which increased crude options at its Memphis refinery, were a contributing factor to the strong performance. A reduction in RIN prices also reduced costs by $124 million. The ethanol segment increased operating income to $43 million from $31 million while Valero Energy Partners' operating income increased to $83 million from $71 million. In keeping with its stated goal of returning 40%-50% of adjusted operating cash flow to shareholders in 2018, Valero paid out $672 million during the quarter, including $345 million in dividends and the repurchase of 2.8 million shares.

Incorporating the latest results, we are increasing our fair value estimate to $100 per share from $95. Our narrow moat rating remains intact.

As a pure-play refiner with a high-quality set of assets, Valero is particularly well positioned to benefit from today’s environment. Shares have responded accordingly, but we think the outperformance of the past year has left valuations at relatively loft levels and indicative of greater than midcycle conditions. That said, the current environment could persist for another couple of years.

Growing crude production relative to transportation availability is likely to support domestic light crude spreads through 2019 when adequate pipeline capacity is in place. Meanwhile, a strong U.S. economy, robust export market, and favorable inventory levels remain supportive of product margins. Finally, RIN prices have fallen on concerns about enforcement of blending requirements, meaning Valero’s costs should remain subdued relative to the last couple of years. Another wild card remains the implementation of IMO 2020 marine sulfur regulations, which could result in several more years of strong distillate margins and wide heavy crude spreads. In such a scenario, Valero’s strong performance could continue for the foreseeable future, and given the company's policy of returning a fixed portion of cash flow to shareholders, it would lead to greater repurchases and dividend increases.