Valero: value or value trap?
Last week, Valero announced the postponement of a major capex project in Port Arthur, a guidance towards a second quarter loss, and a dilutive stock offering. Basically, a triple whammy that sent the stock tumbling from $22 to $18, a near 18% single day loss.
A lot has been written since about how CEO Bill Klesse and Valero management has mismanaged the business and how this company deserves its well below industry average P/E ratio. The all-knowing Jim Cramer even put Bill on the “Wall of Shame.” Is this all an over reaction or was I wrong about my purchase of Valero earlier in the year? Is Valero not truly a value, but a dreaded value trap?
One positive note with regards to last week’s bomb was that Valero was able to issue shares to the market at $18, establishing a relatively acceptable floor for share value relative to its lows for the year.
The decision to issue shares at $18 per share is, however, a pretty damning data point. Management has bought back nearly $9 billion of shares over the last three years at prices near $60 per share and this most recent offering is all but an admittance that they mismanaged their capital allocations. That being said, a year ago, these moves were being lauded as shareholder friendly and the right way to return value to shareholders. At the very least, we know that management has in the past been shareholder friendly (probably to a fault) during flush times.
As far as operations go, the fact that Valero has managed to lose money due in part to downtime at refining facilities as well as lagging demand for diesel and poor sour crude margins this quarter is worrisome. This will require closer attention going forward, particularly if other refiners show an ability to turn profits over the last quarter. My original thesis on refining was that refined product demand ought to pick up before oil prices and as a result provide a synthetic “long oil” position in my portfolio. Unfortunately, it seems that oil futures have once again run ahead of fundamental demand (at least relative to US demand).
Strategically, I believe Valero is on the right track in this downturn. It has reigned in capex, but continues to look to use its industry leading position to find ways to improve the business’ competitiveness. It’s the largest petroleum refiner in the United States, but it hasn’t been complacent expanding into biofuels and making a move into Europe. As the market for fuel and distillates returns, this will only help to ensure that Valero stays on the cutting edge and continues to provide industry leading refining services.
While all the above are important to unlocking value at Valero, my Valero investment thesis is more an asset value play than simply a bet on improving refining margins and that hasn’t changed. Even if you agree with Jim Cramer and other bears out there that say that Valero management has no idea how to run a refiner, the assets the Company owns are worth something. According to the estimates I did in the post linked above, I believe them to be worth at a minimum $12/share and more reasonably $25/share if liquidated. Long term, as the industry rebounds and demand returns, these assets are probably worth significantly more. For a patient investor, this asset value as well as Valero’s continued support of a relatively generous dividend (>3%) should provide reassurance when the rest of the world seems to disagree.
The key to value investing is to invest with conviction when the rest of the market doesn’t seem to agree. Market oscillations and over reactions are a source of opportunity for continued purchasing and dollar cost averaging. Easier said than done. While I’m not selling my shares into the storm, I still find myself a bit shaken by the recent revelations at Valero. Only time will tell if Valero is truly a value or value trap. But, I’m willing to wait.
Disclosure: Long shares of VLO at the time of writing.
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