Valero Energy Corporation

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

Valero Energy Corporation is a multinational energy company, primarily a refiner of petroleum and renewable products.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Valero Energy Corporation (VLO) is one of the largest independent petroleum refiners and ethanol producers in the world. Its operations are primarily focused on converting crude oil and other feedstocks into transportation fuels, petrochemicals, and other refined products. The company also has a growing renewable fuels business that produces ethanol and renewable diesel.

  • Revenue Distribution: Valero operates in three main segments: Refining, Renewable Diesel, and Ethanol.
    • Refining: This segment is the largest, responsible for the majority of Valero’s revenue. It includes the refining of crude oil and other feedstocks into refined petroleum products.
    • Renewable Diesel: This relatively new, but growing segment involves the production of renewable diesel from feedstocks such as animal fats, used cooking oils, and corn oil. This segment is designed to supply the growing demand for lower carbon transportation fuels.
    • Ethanol: This segment produces ethanol from corn and other raw materials, also targeting the renewable fuel mandate from governments.
  • Industry Trends: The petroleum refining industry is cyclical and capital intensive. Profitability is tied to the price of crude oil and the “crack spread” — the differential between crude oil prices and refined product prices. The industry is also facing the global push towards renewable fuels and the corresponding regulatory pressures that are arising.

Competitive Landscape

  • The refining business is highly competitive with a few large players such as Marathon Petroleum, PBF Energy, Phillips 66 and others in addition to smaller regional refineries. As a result of their product commodification, differentiation beyond price is difficult.
  • The renewable fuel business has rapidly developing and competing technologies.
  • The petroleum business, as a whole, is being influenced by many factors like government regulation, technological development, and other geopolitical influences.
  • Valero competes on the basis of cost, efficiency, scale, brand loyalty (if applicable), reliability, access to distribution networks and the ability to manage risk.
  • Companies with a high yield on assets, those with a larger scale of production, or those with a diversified portfolio of assets are better positioned.
  • The industry is intensely competitive, highly cyclical, and capital intensive and subject to disruptions that can be difficult to predict.

Moat Analysis

  • Moat Rating: 2/5
    • Valero’s moat is considered narrow primarily due to its:
      • Economies of Scale: Valero benefits from its size, owning a large network of refineries which allow the company to buy raw materials and distribute products more efficiently. However, it is not a unique advantage and can be replicable by larger players or by industry consolidation.
      • Unique Access to certain distribution channels and scale. The amount of product that Valero produces and distributes can give them an advantage over smaller players. However, this is not a unique advantage and other players could theoretically replicate it.
      • First-Mover Advantage in the Low Carbon Fuels area: Valero is among one of the few major companies that have invested heavily in production of renewable diesel and sustainable aviation fuel. This may bring some advantages, but as more competition enters, the advantage might erode.
    • Despite these factors, the refining business is largely commoditized, making it difficult to differentiate the product. High market volatility and a highly regulated environment also increase the risk of long-term competitive advantage, thus limiting the moat.

Risks to the Moat and Business Resilience

  • Commodity Price Volatility: Valero’s earnings are heavily influenced by fluctuations in crude oil and refined product prices. This price volatility directly impacts revenue and margin stability, which is a primary reason why a “wide” moat is difficult to achieve in the refining industry.
  • Regulatory Changes and Environmental Pressures: The push toward renewable energy may significantly reduce demand for traditional petroleum products, affecting long-term demand for their refining business. Changes in policies or government regulations could make the business unprofitable.
  • Technological Disruptions: New technologies, especially in areas like renewable fuels, electrification of transportation, and improved battery production could reduce demand for Valero’s products. They have tried to counter it with their own investments in renewable energy, but the long-term effect is still unknown.
  • Geopolitical Risks: Being a global company, the operations are subject to political and economical risks, which can affect production and demand. Geopolitical conflicts can have a dramatic impact on crude oil prices and the ability to operate within certain areas.
  • Intense Competition: The refining industry is intensely competitive. New entrants or capacity expansion by incumbents could put pressure on margins and market share, which are core aspects of their business model.
  • Leverage: The current debt position is slightly elevated in the post-pandemic situation with large acquisitions occurring over the last couple of years, any downturn in the industry can put immense pressure on the company.
  • Reliance on Feedstocks: Valero has a high reliance on crude oil and agricultural feedstocks. Any changes in prices of these commodities or supply could have a negative affect on profit margins.
  • High Interest Rates: Recent increases in interest rates may make financing future operations more expensive or decrease profits from lower rates.

Financials Deep Dive

  • Valero’s Overall Financial Health and Recent Performance:
  • Valero’s recent earnings have been heavily influenced by the increased demand and prices after the post-covid downturn.
  • The company reported net income of $3.3 billion in the second quarter of 2023, showing positive results.
  • During the second half of 2023, the company reported a combined operating income of $11.8 Billion dollars, as crude prices reached a maximum.
  • In the recent earnings call, Management has noted that global petroleum demand is robust. It expects lower prices to have a material effect on their refining margins, and a continued high demand to push more refining volume.
  • The company is actively working to transform the business from traditional refining to a more diverse company involved with renewable energy sources.

  • They are expanding and improving operations that facilitate the production of lower-carbon fuels. This will help reduce exposure to future environmental regulation.

  • Debt and Leverage:
    • They had $11.4 billion in long term debt at the end of Q3, 2023
    • The Company has a Debt to Capitalization ratio of 36.1 %
    • The high debt is due to the major acquisitions occurring over the last year.
    • The current interest rates and high debt may impact company performance negatively, but could be helpful in the short term due to inflated petroleum prices.
    • It does however pose a risk in the long term if the business cycle slows down.
  • Liquidity:
    • They have a current ratio of 1.02x, which is acceptable given the company’s size, scale, and industry.
    • Returns:
      • Return on invested capital or ROIC was 21% in the third quarter of 2023, above their cost of capital of ~10-15%. It has shown volatility and is difficult to maintain in the longer term. The ROIC has gone down after the price of refined products have stabilized a little from the highs of 2022.
      • Valero has had excellent return on invested capital over the last two years primarily due to high refined prices.
  • Operating Margins: The operating margins tend to fluctuate wildly based on the prices of crude oil, and the spread between price of crude and refined products. They have averaged around 10% on the last 5 year mark, but there is a massive fluctuation between the high and low periods.
  • Stock buybacks and dividends: Valero has been actively buying its own shares and provides a dividend, indicating that they are creating shareholder value and returning some profits to the investors. It also means that the capital they have generated in a high market is not being used to improve the business, hence they will be relying on current assets and operations to achieve the profitability required by investors.

Management Thoughts on Current Performance:

  • During the recent earnings calls, the company has emphasized their focus on increasing profits in their refining sector while rapidly expanding their renewable diesel facilities. They believe that their position in high-demand renewable fuels will give them an added advantage.
  • Valero has consistently tried to increase shareholder value through share buybacks and dividends. They believe that their main priority for value creation is improving the business, especially its renewable division.
  • Management is also focusing on safety and reliability within their operations, and trying to reduce cost wherever possible.

Understandability Rating

  • Rating: 2/5
    • While the business model is relatively straightforward-refining petroleum and producing renewables it involves an understanding of complicated financial concepts, global markets, and the interplay of a highly complex and interconnected supply chain.
    • The company is a global player and has lots of moving pieces which might be harder to understand.

Balance Sheet Health

  • Rating: 4/5 * The balance sheet is generally strong with a fair amount of current assets to cover for short term obligations and future investments. The debt to asset ratio is acceptable. They also have a high amount of liquidity and are in a good position to face unforeseen circumstances and financial pressure in the short term.
  • The company does have a fairly high amount of debt after their recent acquisitions, but it is not dangerously high. They need to keep an eye on their leverage ratio and debt payments.

In conclusion, Valero has a narrow but defendable economic moat, mainly due to its scale and reach. The company is generally healthy from a financial perspective, but also faces a good amount of risks due to volatile markets, and regulatory uncertainty.