EUR 850.00 For Business Accounts Only

Morningstar | Valero Reports Strong 3Q; Recent Sell-Off Creating Buying Opportunity

Valero's third-quarter results were largely in line with our expectations as net income edged up to $856 million during the quarter from $841 million the year before. Despite higher volumes, operating income for the refining segment slipped to $1.3 billion from $1.4 billion last year, which reflected the benefit of strong margins in the wake of hurricane activity. The falloff from the year before was primarily felt in gasoline and secondary product margins. Ethanol segment income fell to $21 million from $82 million the year before because of lower prices. Operating income for VLP, the midstream segment, increased to $90 million from $69 million a year earlier largely thanks to acquired assets from Valero during the year. Keeping with its targeted 40%-50% adjusted operating cash payout ratio, Valero returned $775 million to shareholders through dividends and the repurchase of 3.8 million shares. Our fair value estimate and narrow moat rating are unchanged.

The past couple of weeks have been unkind to Valero shareholders. Late last week, Valero announced plans to acquire the third of Valero Energy Partners it does not already own. Meanwhile, news circulated that the Trump administration would like to see a phased implementation of IMO 2020 regulations. Those two items sent shares tumbling. We think in both cases the market response was an overreaction. We've already written that the acquisition of VLP is largely a nonevent and resulted in an immaterial impact on our fair value estimate. The potential delay or staging of IMO 2020 is more consequential, but unlikely. It's unclear exactly what actions the Trump administration might have the IMO take, or if it has any ability to influence a regulation that has already been agreed upon and is in affect within U.S. waters. Furthermore, the U.S. oil and gas industry is a likely beneficiary of the new regulations thus providing full implementation of IMO 2020 a powerful constituency.

As we've previously detailed, consensus estimates for 2020 had risen in the past year in anticipation of a tight diesel market from the introduction of IMO 2020. Refining shares have risen in response, leaving them exposed if such high expectations did not come to fruition. We included the impact of IMO 2020 in our near-term forecast but assumed revision to midcycle condition by 2022 and viewed refining shares as largely fairly valued as a result. The recent sell-off has left several refiners including Valero selling at a wide discount to our fair value estimate, which is largely based on normalized midcycle conditions. That said, further headlines surrounding a potential IMO 2020 delay and relatively weak gasoline picture could continue to pressure shares in the near term, but we’d view them as buying opportunities.

For more on IMO 2020 and valuation implications see our Sept. 21 report "Independent Refiners: Laissez les Bons Temps Rouler?".