Valero Energy (VLO) stock has risen by 10% this quarter, driven by refining cracks expanding. Cracks have been growing in anticipation of the IMO (International Maritime Organization) 2020 standards’ implementation. Other refining stocks have also risen. Phillips 66 (PSX) and PBF Energy (PBF) are up 10% and 17%, respectively, quarter-to-date. Let’s look at how Valero’s valuation compares with peers’.
Valero’s forward PE multiple
Analysts are positive on Valero next year. However, they expect the company’s earnings to fall this year due to weaker refining conditions. They forecast Valero’s EPS falling by 31% to $5.10 this year before rising by a whopping 95% to $9.90 in 2020.
Valero stock is currently trading at 19.2 times analysts’ 2019 forward EPS estimate, and 9.8 times their 2020 estimate. Peers’ average forward PE multiple for 2020 is 9.3x. Phillips 66’s, HollyFrontier’s (HFC), and Delek US Holdings’ (DK) 2020 forward PE multiples are also above average, at 10.7x, 9.9x, and 10.6x, respectively.
Why is Valero’s valuation higher?
Valero’s valuation has risen along with its stock price, and has been boosted by its robust earnings outlook. Wall Street has assigned Valero stock a high valuation based on the company’s sound debt and liquidity.
Analysts expect Valero’s earnings to rise next year, driven by its growth activities and IMO 2020. The company has a series of refining and midstream projects under execution and development. Valero expects these projects to add $1.2 billion–$1.5 billion in incremental EBITDA per year in the next three years. To learn more, read Valero Energy Stock: Are Analysts Buying Its Growth Story?
Furthermore, in this year’s first nine months, Valero’s debt ratio was below average, at 30.7%. Its operating cash flow was $3.8 billion, which left it with a surplus after covering its crucial capex and dividend expenses. Valero’s capex and dividend outflow stood at $2.0 billion and $1.1 billion, respectively. To learn more, read How Strong Is MPC’s Debt and Cash Position?
IMO 2020: The game-changer
IMO 2020, which caps the sulfur content in marine fuels at 0.5%, is about to alter the refining environment. Refiners such as Valero are well positioned to benefit from these changing dynamics.
The regulation will create massive demand for low-sulfur fuels, and fewer takers of high-sulfur fuels. Refining cracks will likely widen as demand outpaces supply. Also, as refiners focus on producing low-sulfur fuels, the supply of other refined products such as gasoline could be affected. The constrained supply for refined products could widen cracks.
Oil spreads will also widen as refiners that can’t process sour (high-sulfur) crude demand more sweet oil to fill bunker fuel demand. As a result, the sweet-sour spread will expand, boosting margins for refiners that can process sour crude oil.
Therefore, refiners that can convert sour crude oil to low-sulfur fuels will be the biggest winners, with their cracks sweet-sour differentials improving.
According to Valero, its conversion capacity stands at 30% (of crude distillation). VLO’s capacity stands at the high end of peers’ range of 14%–30%, showing that it is well positioned for IMO 2020. Conversion capacity comprises delayed coking, fluid coking, gas oil hydrocracking, and residual hydrocracking capacities. Overall, Valero’s IMO 2020 positioning, growth and earnings outlook, and strong financials are supporting its stock and valuation.