Valero’s Value in Crosshairs of Oil Markets

This morning has put opposing forces on the oil sector, and Valero Energy (VLO-NYSE) is right there.  Iran’a announcement that it would free the 15 British Navy prisoners immediately had oil futures dropping, with May light sweet crude contracts trading down almost 1%.  ConocoPhillips (COP) said today that 1st qtr oil & gas production was down sequentially due largely to unplanned outages in the U.S., but said that refinery margins were “significantly” higher. 

This news was followed by the weekly inventory data for crude oil and gasoline, with gas inventories surprising big on the downside with a 5 million barrel drop.  The drop is partly due to the refinery problems seen at Valero’s (VLO) 170,000 bpd refinery in Texas, which was shut down after a fire in mid-February and set to re-open at reduced capacity "in a few weeks."  While the refinery issues are obviously bad for Valero in the short-term, the whole mess could have a silver lining for investors, as more attention is being paid to the massive constraints on U.S. oil refining. 

As we highlighted a few weeks ago, rising oil prices and attractive valuations have pushed VLO stock up 24% since the beginning of February.  On today’s news VLO stock was up 1% mid-day at $65.25.   What’s more, Valero is exploring the sale of a 147,000 bpd refinery in Ohio, which the company says it has received “a lot of interest in the plant”, according to comments made at the Howard Weil Energy Conference yesterday.  We think this progressing story is a big plus for VLO investors, as the value of the refineries is the key to determining the worth of the company.   

When we conducted a break-up analysis of Valero in January when the stock was at roughly $53.00, we attempted to estimate the value of Valero’s 18 refineries, which produce much more product than is sold at their retail fuel stations.  We had to rely partly on recent appraisals because of a lack of asset sales in the recent past and that is still a a wildcard.  For a refinery the size of the one in Ohio, the price tag could be in the area of $500 to 600 million; if it goes for more the break-up value of Valero could justifiably be set to a much higher range.  Subjectivity may be used on each refinery, part due to the operating condition and geography of each and part to the "lack of new refineries" coming online.   

We’ll still have to see what kind of costs and charges were incurred with the Texas facility, and news of recent gas shortages at Valero stations in Colorado certainly don’t help foster good PR.  But Valero is still mainly a refiner (not a retailer), and 17 of 18 refineries have still been pumping out higher margin product all quarter.  It also claims some 5,800 combined retail and wholesale stores in the US, Canada, and the Caribbean under various names.

The stock now sits some $4.00 over our value we were able to place on it then, so now it may boil down to the prices people are paying for gas and what this refinery will ultimately fetch in a sale.  Updates will be forthcoming on any news of asset sales, as they may materially impact the valuation models used for the company, including ours.

Ryan Barnes
April 4, 2007

Edited by Jon Ogg

Ryan Barnes can be reached at [email protected]; he does not own securities in the companies he covers.