Valero shares set to trade ahead of pre-war levels (NYSE: VLO)

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Posted on the Value Lab on 3/22/21

The oil situation continues to be volatile around headlines about the war in Ukraine. Even mentions of import bans drive up the price, and so does any failure to complete peace talks. We don’t see the end of the war anytime soon, as Russia has the resources to pursue it despite its ineffectiveness, and while we believe tougher interdictions are unlikely given Europe’s dependence on vis Russian commodities, more sanctions will be coming as the war drags on. Oil has many reasons to be at current levels, and it will be at the expense of the crack spread, currently levitated by some very high product spreads, that refiners like Valero Energy Corporation (NYSE: VLO) earn their margins on. However, we believe there are risks on the horizon that will reduce the price of oil, but contribute to a situation where refiners should be more resilient relative to E&P. With Valero trading at a fairly reasonable multiple, and being a mainstay through the 2020 crisis at least with its dividend maintained, we think it’s a pick investors should watch as it might even be worth trading beyond. pre-war levels.

Why oil is most likely to fall

Capacity constraint was why we saw the commodity boom we are experiencing right now. The one booming commodity that doesn’t appear to be capacity constrained is oil. The rise in oil is linked to several factors. The first concerns trading conditions, in which traders limit their options and their value by not doing so much with major Russian oil exports as they want to avoid sanctions. We are also seeing some recovery in oil demand as things start to open up again. Finally, there is no respite from US, Saudi or other OPEC producers.

What could change?

The fact is that high oil prices are a political issue for almost all world leaders, except for oil-producing countries where higher exchange rates and better terms of trade are a boon. Biden is courting previously spurned governments like Iran and Venezuela to start leaving their production to the markets. There is some debate as to how quickly this would accelerate, but they are both well endowed and their supply is capable of moving the markets. Moreover, if some countries break out of the general ranks that OPEC maintains with tight taps on oil, OPEC could be incentivized to follow volume to keep profit volumes from their oilfields at low break-even cost. We could see significant declines due to these factors. Moreover, peace in Ukraine could also come suddenly and be a catalyst for lower oil prices.

It is also possible that Biden will activate the green program and allow more shale expansions. That seems unlikely, however, as his polls are underwater and the economic situation is already cause for concern for him, and for Democrats to worry about in the medium term.

VLO seems a good choice

Why then are we interested in refiners? Well, if crude prices go down, that would be good for the spread of crack. However, certain situations in which crude falls, such as peace in Ukraine, could also be accompanied by falling prices for crude products produced in Caucasus refineries. Crack spreads would not improve in this case, and might even decrease as the upside opportunity diminishes. It wouldn’t be a disaster, it would just be more of the 2021 situation.

But in the situation where the major oil comes from Iran and Venezuela, the dynamics would be much more favorable to refiners. The crude would of course fall, but the crude coming out of these countries is very sour. Moreover, their refineries are very old and poorly equipped due to years of sanctions. Sour crude that would come out of these geographies would need to be refined by high complexity refiners, and the best geography for that would be the Gulf Coast. Growing volumes would reduce crude prices, and the value added of complex refiners would also increase to deal with the sour crude that would come out of these potentially re-entering geographies.

The company is currently trading at a multiple of just over 10x on 2021 EBITDA, in line with peer Hollyfrontier (HFC). The outlook is good for EBITDA next year with crack spreads almost at 2012 levels.

the crack is spreading

crack spreads (

Even if the current commodity spreads cannot be sustained with further changes occurring in the oil markets, we believe that in the most likely scenarios as politicians attempt to rectify the energy situation, oil prices will fall and l The introduction of Venezuelan crude, which is still speculative, as well as Iranian crude which seems more likely with the relaunch of the Iran deal, will keep refining margins above levels seen in the market for 2021. VLO is still trading at the same levels as at the end of February. We believe that under the majority of circumstances, including a continuation of current circumstances with crack spreads leading to a boom in refinery profits, VLO and others should trade significantly ahead of 2021 levels. fall and product spreads fall, then at least the DGD business, which now accounts for 25% of operating income, remains more stable on the sidelines with tax credits and more resilient freight and logistics demand for diesel keeps this division healthy. Plus, you only pay a little over 10 times for the business of the worst-case scenarios where EBITDA does not improve particularly from 2021. For value-proven industrial assets, and possibility of increasing the flow still around 10% below 2019 capacity levels, we think the risks are fairly low, especially with a robust 4.2% dividend.

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Stock VLO at pre-war levels (Google Finance)

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