Valero's Refinery Base Robust, Weak Ethanol Business A Drag

On Jun 8, 2016, we issued an updated research report on Texas-based Valero Energy Corporation (NYSE:VLO) .

Valero offers the most diversified refinery base among all independent refiners with a capacity of 3.0 million barrels per day in its 15 refineries across the U.S., Canada and the Caribbean. Also, Valero is poised to benefit from the increased refining margins on the back of its strategic refinery structure that enables it to use cheaper oil for more than half of its needs.

This Zacks Rank #3 (Hold) stock is one of the leading refiners in the world with a low cost asset base. It refines cheaper, lower-quality oil and sells some of its yield in profitable international markets. Interestingly, the company has reduced its exposure to the East Coast markets, which are currently unprofitable. Most of the company's assets are concentrated in the profitable regions like the Gulf Coast and Mid-Continent.

The energy firm expects to spend $2.6 billion on capital projects in 2016 of which, $1 billion has been earmarked for growth investments. The company will now be able to concentrate its capital on strategic growth projects as well as turnarounds. It is also likely to witness an improvement in free cash flow, which will enable it to return more to shareholders via dividends, share buybacks and through debt reduction planned for 2016. Notably, the company increased its quarterly dividend three times in 2015.

The continued weakness in crude prices is likely to result in higher gasoline demand, especially during the summer driving season. Hence, growth in refined product sales should support earnings at Valero Energy.

The refining segment, which contributes the bulk of Valero’s revenues and earnings, is a major growth driver to the company's results. However, with refiners being buyers of crude, the profitability of these companies might be limited by an increase in oil prices.

Moreover, the inherent volatility of the refining business reduces the accuracy and reliability of long-term earnings and revenue estimates. This apart, Valero’s results are exposed to unplanned shut-downs that may have a lasting impact.

The requirement of policies to reformulate fuel and lower emission from refinery operations make the industry a highly regulated one. As a result, companies like Valero are often forced to divert cash flows to ensure regulatory compliance, which in turn, can adversely impact profitability.

Further, Valero Energy expects a fall in throughput volumes in 2016. Also, continued weakness in its ethanol business is likely to negatively impact earnings for the firm.

Stocks to Consider

Some better-ranked stocks in the oil and gas sector include CVR Refining, LP (NYSE:CVRR) , PetroChina Co. Ltd. (NYSE:PTR) and Braskem S.A. (NYSE:BAK) . All these stocks sport a Zacks Rank #1 (Strong Buy).