Is Valero Stock Undervalued?

When crude oil traded at $73 per barrel at the start of the year, few could have predicted it would soar to $91 per barrel 9 months later and fewer still that it would plunge to $68 just 8 weeks later but that’s precisely what has happened and it’s hurt a lot of oil stocks who are tethered to the price of oil.

Valero (NYSE:VLO) is one such stock whose share price this year has closely mimicked that of crude oil, but where oil is still down for the year VLO share price is up year-to-date by 7.1%.

Will a return to higher oil prices next year spur further bullish momentum? And if so, is Valero trading at a discount to fair value now?

Get To Know Valero

Valero might be best known to most investors as just another gas station down the street but as a leading refiner it has a global presence with operations the US, United Kingdom and Canada, ensuring that it’s not tied to the fortunes of any specific region.

The company’s international presence is made possible by its sophisticated logistics network of pipelines, truck fleets, and terminals that ensure efficient distribution.

It’s also capable of processing a wide range of crude oils so price and availability variables can be analyzed in rapid order and optimized to maximize revenues. In that same vein, the refiner’s vertical integration that extends to the retail market ensures it can capture additional margin and boost brand visibility.

All that combined has led to a financially sound company that is looking ever more attractive from a value standpoint.

Is Valero Stock Undervalued?

According to 20 analysts, Valero stock is undervalued by 18.6% with a price target of $149.54 per share.

A 5-year discounted cash flow analysis would suggest even higher upside potential with fair value lying at $177 per share.

And offering a 3.17% dividend yield now with just a 13% payout ratio, it seems there’s lots to like for income-oriented investors who are seeking a sustainable dividend that could rise over time.

So, is it time to jump on board?

Is Valero Stock a Buy?

Let’s get the bad news out of the way upfront because there is so much to like about Valero that it’s almost difficult to know where to begin.

On the bearish front, seven analysts have revised their earnings estimates lower for the next period.

Additionally, gross margins are fairly weak at Valero, coming in at just 11.3% last quarter.

On the bullish front, a laundry list of positives exist. For one, Valero is trading at a price-to-earnings ratio of just 4.3x, a number so low that it’s hard to ignore and highly compelling to value-oriented investors.

Speaking of profitability, Valero’s PEG of just 0.16x suggests it’s trading at a real discounted to future earnings growth.

Next is the bullish column is the free cash flow yield that sits at an extraordinarily high 25.2%. Cash flows are the lifeblood of a business and crucial to paying down debt as well as dividends and it’s in this area that Valero really shines.

On the debt front, the company is saddled with $11.4 billion of total debt but that doesn’t seem excessive when it’s generating $145.5 billion in revenues. Furthering that point, the total debt to equity ratio stands at just 40%, a modest enough level for such a capital intensive business. It’s also got $5.8 billion of cash to rely on if needed.

Turning attention to profitability, the firm’s 29.2% return on invested capital is evidence of how efficient it is at converting capital into real value.

What that’s all boiling down to is insiders getting clearly quite excited by the prospects of the firm. In September, the Board of Directors announced a share repurchase scheme to the tune of $2.5 billion, reflecting the clear confidence of management in the higher value of the firm now relative to its price.

Time To Buy Valero?

The fortunes of Valero are largely tied to the swings in oil price and, as that has declined, so too have revenues which fell 14.6% last quarter. That followed declines of 34.4% and 5.7% in the prior two quarters, respectively. In spite of the slide on the top line, the company reported operating income of $3.5 billion.

Overall, the company scores well on key risk metrics too, with cash-to-total capital at 10.2%, a current ratio of 1.5x and interest coverage ratio of 25.5x. That compares well to BP at 17.1x and Conoco Phillips at 23.5x.

Clearly, management is doing a lot well and it’s evident in key metrics like the return on equity of 44.7%. Indeed, they are doing so well that they are willing to bet $2.5 billion on a share buyback scheme that will result in higher earnings per share as the overall share count drops, all else being equal.

From a valuation perspective, it’s clear analysts and cash flows analyses both assess the stock to be on sale at these prices. Any uptick in the price of oil should lead to higher revenues and profitability, which in turn should materially benefit VLO share price.

With $11 billion in levered free cash flow, the company is well positioned to continue to reward loyal shareholders who are looking for a generous dividend that is sustainable, and who are keen to own an energy company with a strong balance sheet that is positioned well to weather economic hardship.

The bottom line is the pros are numerous and the cons are limited so, if there is a time to buy Valero, now seems to be about as good as any.

---

The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.