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Valero Margins Stabilize, Now Must Stare Down Ike

Posted on | September 10, 2008 Time: 2:54 pm |

Valero (VLO) shareholders must be looking for the Candid Camera crew these days. Just when it appears that margins for the mega-refiner are stabilizing, Hurricane Ike is on a path towards the Texas gulf region and some of the firm’s most valuable refineries are in the crosshairs.

VLO shares are down over 50% this year, first being hit with nosebleed crude oil prices then a surprise slowing of demand for gasoline and other distillates this summer. Valero’s ability to process heavy sour crude for over half of inputs gives it a huge advantage over rivals like Tesoro Corp. (TSO) and Sunoco (SUN). And even though they’ve been unable to make further progress in their asset sales in ‘08 because of dried up credit markets, refinery prices pegged from last year’s sales put a strong floor under the stock.

Just when crack spreads are finally opening up, Ike looks dead set on driving through a key refining region for Valero. The company’s facilities at Corpus Christi, Texas City, and Port Arthur are right in the path for Ike’s landfall. If it comes in at a Category 3 like the consensus models indicate, Valero might not luck out the way they did with Gustav.

Refinery outages are a simply cost of doing business in this industry - because no new refineries have been built in the U.S. in over 25 years, the existing facilities are constantly being given industrial band-aids to keep up and running. Valero for their part has some of the most technologically advanced refineries on the planet, especially in the Gulf area. The combined throughput of the 3 Texas facilities is around 800,000 bpd, or more than 25% of Valero’s total capacity.

If there are prolonged outages following Ike’s landfall, distillate prices in the region are likely to rise, so there is a modest silver lining. Crude oil now down 40% from its peak, so crack spreads are bound to be better than we’ve seen for the majority of 2008. At less than 8x trailing earnings, Valero shares are a compelling value absent any real estimates of potential hurricane damages. Investors should tread cautiously over the next week, both for weather reports and to see how the recent energy sector sell-off plays out.

Epiphany Investing

Disclaimer: Author does not hold any positions in the securities mentioned.

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