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December 2, 2015

Idea Of The Week: Valero May Be A Bright Spot On Energy Scene

by Steven Carroll.

It’s been a tough 12 months for the energy sector. Check out the chart below, showing the DJ U.S. Energy Index. From a July 14 high of 848, the index plumbed levels below 500 before rallying back to the current level of 569. Most energy companies have taken a hit, but has the baby been thrown out with the bathwater?

We decided to see if there are companies that continue to perform well despite front month oil futures hovering around $41, down from a trading range between $80 and $110 in the past three years.

Source: Thomson Reuters Eikon

Source: Thomson Reuters Eikon

Drilling for value

One names that stands out is Valero Energy Corp. (VLO.N), the $35 billion refining behemoth that now trades on a forward P/E of exactly 10, and that StarMine calculates is trading at (neatly) exactly 50% of fair value.

Source: Thomson Reuters Eikon

Source: Thomson Reuters Eikon

Actual stock price gains

Unusually for the industry, VLO’s stock price is hitting new highs, closing on Dec. 1 at $72.57 – up 46.6% YTD. The stock is in favor with credit markets also, with the 5 year CDS having declined sharply in recent months (purple line in chart above).

What’s driving the stock’s significant outperformance? Well, we’re not dealing with a company that’s been wrong footed by the oil price. Q3 earnings saw that management continues to buy back shares – utilising the company’s strong free cash flow, while also signalling its confidence in the future outlook with a 25% increase in the dividend. These shareholder friendly strategies are looking pretty good and certainly shareholders and the sell side are cheering along.

If we take a look at the suite of StarMine Predictive Analytics we can see other reasons to be positive.

Source: Thomson Reuters Eikon/ StarMine

Source: Thomson Reuters Eikon/ StarMine

Ticking the boxes

  • Earnings Revisions – the ARM score is in the 90th percentile indicating a strong likelihood of future positive revisions (and there is currently a 2.1% Predicted Surprise for EPS on 2016).
  • Intrinsic Value – The StarMine IV score is in the 96th percentile – signalling a mispricing between market implied growth and StarMine’s own forecast (which takes Sell Side Analysts forecasts and reduces them based on an algorithm that takes into account likely over-optimism). The overall ratio is 0.5 meaning Valero is trading at half the calculated fair value.
  • Relative Value – A score of 89 indicates this valuation measure is also attractive – taking into account key metrics on both a trailing and forward basis. Additionally, the company’s metrics look attractive compared to peers – it’s P/E of 10 compares favourably to the peer median of 11.7 and EV/EBITDA also looks attractive at 4.9.
  • Smart Holdings – the stock scores in the 90th percentile indicating that its metrics are likely to be attractive to the institutional asset management community – where we analyze the holdings of 1000+ fund managers to try and discern styles that are in favor (growth, value, ROE, leverage, momentum and so on) and then project stocks that are likely to see an increase in institutional ownership on this basis.

So for those who may seek dependable energy exposure without the high betas of the smaller end of the market, here’s an interesting play. A defensive stock that has now “surged” to a P/E of 10x still looks very reasonable given the medium term uncertainty over the oil price. You also get a 2.8% dividend yield while you wait. In an uncertain and volatile market, one can understand the attraction that’s driven the stock to current levels.

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