VLO Is Conservatively Valued

Summary

  • Valero (VLO) is conservatively valued on an absolute basis according to a Discounted Cash Flow Analysis.
  • VLO is conservatively valued on a relative valuation basis against its peers group.
  • Conservative valuation reflects expected margin contraction. Even though analysts’ 2015 earnings estimates are still biased high, ample margin of safety makes VLO a long-term HOLD.
  • If/when estimates do come down, VLO is a BUY on the dip.
  • Although good things are more likely to happen to conservatively valued stocks, a separate thesis is needed to indicate how management would unlock value.

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A Crash Course in Refining Fundamentals

Summary

  • Refiners make money by cracking crude oil throughputs into valued-added products (i.e., yields). Crack spreads are cyclical and volatile.
  • Refiners have adapted to margin volatility by engaging in derivatives contracts which off-set short and medium commodity price risks and by investing in assets which are able to process cost-advantaged crudes and optimize yields of higher value products.
  • Vertically integrated refiners are further able insulate themselves from commodity risks and exert more pricing power.
  • Ceteris parabus, long-term crack spreads will be upheld simply due to the fact that markets tend to value refining assets at or below their replacement costs (RCN).
  • Compliance and regulatory measures are a more serious threat to the long-term viability of domestic refiners since they often elicit unintended economic consequences.

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