Valero is a Texas based refiner which owns 15 petroleum refineries located in the U.S., Canada, and the U.K. with a combined throughput capacity of approximately 3.2 million barrels per day, as well as interests in ethanol and renewable diesel plants. The company will go ex-dividend on May 12, the quarterly dividend amounting to 98 cents per share. Q1 was the company's best quarter in 7 years, with net income of $905 million or $2.21 per share. The company is benefiting from the record crack spread, which is at levels not seen in recent decades (yes, decades, see article below). Recent trading has seen VLO's market cap surpass PSX and MPC.
Why short a strong stock in the strongest sector of the market?
Valuation concerns From the company's Q1 2022 earnings call: "Manav Gupta - Analyst, Credit Suisse I'm going to try for one. I'm not sure if I get the answer, but it's my job to try. So if we go back a decade, 2015 was the best year in earnings. And let me know how if I'm wrong, but I think you made over $9 in EPS in '15. So when we move forward today, first quarter 2.31. The next two quarters, most of us who really believe in Valero believe there's like an $8 or $9 EPS number hidden there combined for the 2 quarters. And then the last quarter is generally our strongest. So that's another 2.50. We put all three things together this high that will be achieved in 2022 will be materially higher than the 2015 earnings number. If I'm thinking about it right, can you comment about how the management is thinking about a record high earnings in over a decade. Joe Gorder - CEO So Manav, I'll just say that -- I said it earlier, we live one day at a time. And we certainly like your thinking and your mindset. And frankly, I think everything you've heard from the team this morning is that things look constructive on all segments of our business right now. And so we're optimistic, but we don't cut our chickens before they're hatched. So we'll continue to do what we do, and that is coming every day and try to operate safely and reliably in an environmentally responsible way and to optimize to the extent we can. And if we just keep doing that day after day after day, I think we're going to find ourselves in a really good place." The analyst's projection is for around $13 in EPS for 2022. For context, the EPS was $2.27 for 2021 and negative $3.5 for 2020. Using the analyst estimate EPS, the forward PE on this stock is 9.2x. It looks alluringly cheap. However, that valuation is based on peak margins and peak earnings. To take that as a benchmark means that we continue to expect record earnings in future years. There are several mega refineries coming online in Africa, the Middle East and Asia which make me doubt that record earnings will continue (picture below on refinery closures and opening by region). If EPS drops to a more modest $4, which is still high by historic standards, the stock's PE rises to 30x.
Parabolic topping pattern on the daily chart
Looking at the copper price makes me seriously doubt the stagflation thesis. If we are entering a period of slowing growth and slowing inflation, chances are crude oil has topped. Lumber and nat gas corroborate that view. If that's the right interpretation, oil should soon start to underperform. Price-wise, VLO moving below $115 would signal the start of a correction to the parabolic move but I'm confident enough in my assessment to front run the entry.
Sentiment
The analyst consensus is 18 buys, 1 hold and 1 sell, with an average price target of $121.74. The price target has been constantly revised higher as the stock moved up. For context, the price target was $90.44 one year ago.
Entering now with a stop just above the 52-week high of $129.27 gives a favourable risk:reward setup. The company has not been using its record earnings to pay down debt, so the leverage (debt-to-equity ratio of 0.7x) should add fuel to the move down if fundamentals deteriorate.
The stock is currently trading ~$120 and I'm short.
Good Trading!
Kashyap