Revisting Valero's Break-Up Value (VLO)

Crude oil and natural gas prices have quietly been on the rise for most of 2007, and Valero (VLO-NYSE) has greatly been the beneficiary.  Spot prices for North Sea Brent were just under $62/barrel after rising over a dollar today, equaling the highs we saw in the latter half of 2006.  Investors should assume a very hawkish stance towards following where prices go in the upcoming weeks, as we may well be at an inflection point. Oil prices are oil prices, and if T. Boone Pickens gets it wrong sometimes then you know oil acts with a mind of its own and sometimes outside of logic.

A technician might say with some conviction that the charts for oil and natural gas don’t look favorable to those who want to see lower prices, which includes the majority of the (sans-energy) corporate world, consumers, and politicians on both sides.  Some companies stand to benefit greatly from higher raw prices, as higher raw prices lead to higher profits for refiners, such as Valero (VLO-NYSE).  As the largest independent refiner in the US, Valero also has some protection to its business since getting new refineries built is more than a challenge because of the regulations.   

We covered Valero (VLO) in one of our break-up analysis pieces back on January 29th.  At the time VLO stock was trading around $53.00, and we were assuming that the supreme value of their refineries was magnified because nobody is getting clearance to build more refineries and it is almost as difficult to increase refining capacity at existing plants.  One refinery is temporarily down because of an accident but that doesn’t bring about new refineries overnight and the higher prices are more than making up for it.  A nationwide capacity restraint becomes quite the cash machine for Valero at higher price levels.  This is particularly true if you consider that VLO produces more oil than it sells in its retail operations that it can sell into the markets, so it benefits from gradually rising rising prices. 

The stock is trading up over 4% this afternoon, and currently sits back over $60.00 for the first time since last summer.  The street may even be treating this one as a defensive stock because of its mega-low P/E of under 9.0 on a current and forward basis.  This $60.00 price today is slightly above what was our stated break-up value of $59.00, but keep in mind that a break-up values are meant to be guides of what a "Fair Value" estimate is from those who analyze break-up and merger valuations.  Oil was about $52.00 to $53.00 at the time.  We will be the first to admit that break-up values are based on a snapshot and based on interpretations, and to a behemoth that is going to put capital into the game the implied values will be much higher to some and lower to others.

Valero still trades for about 8.6 times earnings even after the recent run-up.  If crude oil & gas prices trend higher from here, Valero and others in the sector could vastly improve their operating margins and possibly their earnings multiples.   If oil STAYS at these levels it would increase the perceived break-up values,  but we already stated that the oil markets act with a mind of their own.

Most of the refiners and integrated oils are trading higher today since oil inventories fell more than expected, but VLO is today’s leader of the oil patch.  Exxon has been making presentations to analysts today in New York City.  Tesoro (TSO) shares are up 3.6% at $95.09 and Sonoco (SUN) shares are up 3.9% at $66.30.  Exxon Mobil (XOM) shares are up 2.2% at $72.57 and Chevron (CVX) is up 2.5% at $69.35. 

Written by Ryan Barnes
Edited by Jon C. Ogg
March 7, 2007

Jon C. Ogg can be reached at [email protected]; he does not own securities in the companies he covers.