I probably should have written about this earlier as I picked up a position in Valero a few weeks ago around the $18-$19 range. The valuations presented here are a bit crude (pardon the pun). But, in my opinion, an equity investor ought to be more interested in being directionally correct than being exact when modeling. In the end, all we’re looking for is satisfactory margin of safety. On a final note, I have to give credit to Chad Brand at Peridot Capitalist for getting me interested in this one.
What is Valero?
Valero is one of the largest oil refiners in North America. It makes money processing oil and selling the resulting gasoline, distillates, and petrochemicals. While Valero operates in a commoditized industry, it operates the most technologically advanced refineries available and achieves cost advantages through the ability to process heavy sour crude. Heavy sour crude is cheaper than typical crude oil and allows Valero to extract higher margins than its competitors. For more a short primer on Valero, check out this Investopedia Article on Valero.
Valuation Study
PE Ratios
At $15-$20 per share, Valero trades between 3.5x and 4.0x TTM earnings. This is compared to an industry P/E at approximately 8.0x TTM earnings. Specific publicly traded comparable refiners including Holly Corp (7.95x), Tesoro (11.34x), and Sunoco (8.54x) all trade at significantly higher price to earnings ratios.
Even if current earnings levels prove to be the run-rate level for the next few years, Valero’s low P/E ratio ought to trend upwards as it proves the stability of its earnings. Generally speaking, no-growth P/Es range in the 6-8x range which also happens to be the industry average P/E. Valero management’s friendliness towards distribution of its cash through share buybacks and a hefty dividend (currenty 3.5%-4.0%) will only support such multiple expansion as investors become more comfortable with its baseline cash/earnings generating strength.
Balance Sheet Analysis and Liquidation Value
Multiple analysis and subjective research only serve to establish the guidelines for our “bull” case. To establish that we have some margin of safety, we must look towards establishing a more conservative valuation of the business disregarding any long term growth potential. (i.e. the “Ben Graham Valuation”)
As you can see from the above, Ben Graham might not actually agree with my assertion that Valero is a great value. The Company’s net-net working capital - the money the firm could return to investors if it shuttered its doors today - is negative. But, what we do know is that refineries and many of the properties that Valero owns are very valuable. And, if we look at net tangible assets based on Valero’s own balance sheet, we find that the firm is worth $29/share. It’s book value is an even more impressive $36/share. Basically, what we find is that the stock currently factors in a 20% haircut to its net PP&E.
Another thing we can look at is what the firm is worth based on recent asset sales and listings. The most recent listing price (based on estimates from Epiphany Investing) for Valero’s Aruba facility is less than inspiring as it implies a value for the firm around $11.50/share. The average selling price of the firms last two realized sales, on the other hand, paints a much more reassuring story and gives us confidence that current price levels probably represent a reasonable margin of safety provided we believe that gasoline demand will return in the future.
Conclusion
All in all, we find that Valero is currently trading in line with rough liquidation valuation and at a significantly discounted multiple versus its peers. There are significant headwinds for the industry over the next year, but one can be sure that these are likely transient in the two plus year time frame. My opinion is that Valero’s current pricing is very compelling.
Full Disclosure: Long shares of VLO at the time of writing.
By Dan Hung
December 23, 2008
www.thecuriousinvestor.com
What is Valero?
Valero is one of the largest oil refiners in North America. It makes money processing oil and selling the resulting gasoline, distillates, and petrochemicals. While Valero operates in a commoditized industry, it operates the most technologically advanced refineries available and achieves cost advantages through the ability to process heavy sour crude. Heavy sour crude is cheaper than typical crude oil and allows Valero to extract higher margins than its competitors. For more a short primer on Valero, check out this Investopedia Article on Valero.
Valuation Study
PE Ratios
At $15-$20 per share, Valero trades between 3.5x and 4.0x TTM earnings. This is compared to an industry P/E at approximately 8.0x TTM earnings. Specific publicly traded comparable refiners including Holly Corp (7.95x), Tesoro (11.34x), and Sunoco (8.54x) all trade at significantly higher price to earnings ratios.
Even if current earnings levels prove to be the run-rate level for the next few years, Valero’s low P/E ratio ought to trend upwards as it proves the stability of its earnings. Generally speaking, no-growth P/Es range in the 6-8x range which also happens to be the industry average P/E. Valero management’s friendliness towards distribution of its cash through share buybacks and a hefty dividend (currenty 3.5%-4.0%) will only support such multiple expansion as investors become more comfortable with its baseline cash/earnings generating strength.
Balance Sheet Analysis and Liquidation Value
Multiple analysis and subjective research only serve to establish the guidelines for our “bull” case. To establish that we have some margin of safety, we must look towards establishing a more conservative valuation of the business disregarding any long term growth potential. (i.e. the “Ben Graham Valuation”)
As you can see from the above, Ben Graham might not actually agree with my assertion that Valero is a great value. The Company’s net-net working capital - the money the firm could return to investors if it shuttered its doors today - is negative. But, what we do know is that refineries and many of the properties that Valero owns are very valuable. And, if we look at net tangible assets based on Valero’s own balance sheet, we find that the firm is worth $29/share. It’s book value is an even more impressive $36/share. Basically, what we find is that the stock currently factors in a 20% haircut to its net PP&E.
Another thing we can look at is what the firm is worth based on recent asset sales and listings. The most recent listing price (based on estimates from Epiphany Investing) for Valero’s Aruba facility is less than inspiring as it implies a value for the firm around $11.50/share. The average selling price of the firms last two realized sales, on the other hand, paints a much more reassuring story and gives us confidence that current price levels probably represent a reasonable margin of safety provided we believe that gasoline demand will return in the future.
Conclusion
All in all, we find that Valero is currently trading in line with rough liquidation valuation and at a significantly discounted multiple versus its peers. There are significant headwinds for the industry over the next year, but one can be sure that these are likely transient in the two plus year time frame. My opinion is that Valero’s current pricing is very compelling.
Full Disclosure: Long shares of VLO at the time of writing.
By Dan Hung
December 23, 2008
www.thecuriousinvestor.com
