With the summer driving season coming upon us, energy stocks look to be revving up. But while the price of crude oil jumped back above $101 a barrel on Wednesday, prices are still below a three-week peak in April that saw prices hanging mostly above $110 a barrel.
With lower oil prices, is independent oil refiner Valero Petroleum (NYSE:VLO) a buy?
While it may sound counterintuitive, oil refiners such as Valero actually benefit from lower oil prices. That’s because when oil falls, refiners reap a benefit in so-called crack spreads.
A crack spread is the difference between the amount paid for crude oil and the cost to refine this oil. The greater the price differential, or spread, the more the refiner makes. The term comes from literally “cracking” large chains of hydrocarbons into smaller, finished molecules used in products like gas and diesel.
Valero is currently benefiting from near-record crack spreads, which are around $25 a barrel — about double from this time last year.
And since Valero is the largest independent oil refiner in the U.S, it is especially attractive compared to more integrated oil companies, like Chevron (NYSE: CVX) and ExxonMobil (NYSE: XOM), whose profits come from other sources.
Furthermore, because Valero specializes in processing a cheaper grade of crude than some of its competitors, the company can potentially profit more because it pays less upfront to purchase lower-grade crude.
As a result Valero’s refining margins look solid. And, the company appears fundamentally strong.
In the first-quarter the company swung to a profit from a loss a year earlier. Margins, per barrel, were around $9.70 in the mid-continental U.S., where the bulk of Valero’s properties lay. This margin is among the highest in recent history for the area.
With continued global demand fueling refining margins, analysts project Valero’s full-year 2011 earnings will soar by 115% to $3.48 a share. By 2012, they are projected to edge up further to $3.75 a share.
Revenue is also expected to increase. With continued growth, analysts’ project full-year 2011 revenue will increase nearly 30% to $106.4 billion, from $82.2 billion the previous year. By 2012, revenue is expected to inch up a further 3% to $109.5 billion.
Valero’s stock also is reasonably valued with a forward price-to-earnings (P/E) ratio of around 7.
This P/E ratio gives Valero an attractive forward PEG ratio (P/E divided by Growth rate) of about 0.8. As my colleague Peter Cohan mentioned in his April article comparing Exxon to Valero, Exxon’s forward PEG ratio is nearly double, at 1.4. A PEG of 1 or under shows a stock is well-valued.
Valero also has a low price-to-sales (P/S) ratio of about 0.2. A P/S under 1 shows good value. In comparison, Exxon has a slightly high P/S ratio of about 1.1.
Additionally, Valero also offers a reasonable forward annual dividend yield of about 0.8%.
With growing fundamentals, driven by increasing crack spreads, I believe Valero presently offers a bullish opportunity for traders and investors.
At the time of publication, Deborah O’Malley owned shares of Valero.
