Stock Purchase: Valero Energy (VLO)

After a string of REIT purchases lately in Realty Income Corp (O) and W. P. Carey (WPC) it’s time to shift to a new sector.  I am extremely bullish on Foot Locker (FL) but the stock has run up over $5 on me since I did my analysis.  I’m kicking myself for setting a limit order and not just buying FL at ~$62.20.  My next choice was to turn to a sector that I, and most of the DGI community, believe to be on sale right now – energy.

I already have a large position in Chevron (CVX) and a medium sized position in ExxonMobil (XOM), so I looked back at my recent dividend growth stock ranking screen to pull out some other high scoring energy stocks.  It turns out that Valero Energy (VLO) was the top ranking energy stock for two months in a row!  VLO received a score of 8/10 in May and 8.25/10 in June, making it worthy of a closer look and eventually a spot in my dividend retirement portfolio.

In this post I will present my VLO stock analysis and my purchase details.

 

Overview of Valero Energy

Source: S&P Capital IQ

Headquartered in San Antonio, Texas, Valero Energy Corporation is the world’s largest independent petroleum refiner and marketer, supplying fuel and products with 16 refineries and 10 ethanol plants stretching from the U.S. West and Gulf coasts to Canada, the United Kingdom and the Caribbean. Its refineries produce conventional gasolines, distillates, jet fuel, asphalt, petrochemicals, lubricants, and other refined products.

The company operates in two business segments: Refining (operating income of $4.22 billion in 2013; operating income of $4.45 billion in 2012), and Ethanol (operating gain of $491 million in 2013; operating loss of $47 million in 2012).

 

 

VLO Dividend Stock Ranking Results

First off, here is how Valero Energy scored 8.25/10 in my recent screen:

For detailed explanations of each category and parameter check out my initial dividend growth stock ranking post.

VLO received 3.5 / 5 possible in the dividend strength category, 4 / 4 in the financial strength category and 0.75 / 1.5 in the subjective category.  Now let’s dig a little deeper into each category.

 

VLO Dividend Strength

Valero has a dividend yield of 2.6% which is in line with it’s oil & gas refining & marketing peer group.  My screen gives partial credit (0.5 points) to stocks with yields between 1.5-3%.

VLO really sets itself apart from it’s peers with an extremely high dividend growth rate.  The CCC list reports VLO’s 5-year dividend growth rate to be 13.9% – not bad.  Guru.com says the 5-year growth rate is 25.4%.  Even better!  Both of these values pass my 10% threshold to receive a full point for the dividend growth rate parameter.

But still, the discrepancy in the growth rates bothered me.  To see which figure was correct I ran the numbers myself.  Here is Valero’s 5-year dividend growth:

 

 

The increases by year from 2010 – 2015 are as follows: 50%, 117%, 31%, 24% and most recently (2014-2015) 52%.  It turns out that the CCC list was correct, but they calculate the 5-year growth rate based on dividends paid from 2009-2014.  I can’t figure out how Guru got to 25.4%.

If we make the assumption that VLO will at least maintain their quarterly dividend for the rest of 2015 the dividend growth rate gets much better.  By my calculation the 5-year CAGR (2010-2015) of the VLO dividend is 51.6%!

The large discrepancy between my value and the CCC value stems from the fact that VLO cut their dividend in 2010 from $0.60 to $0.20 annually (boo).  This cut is included in the CCC calculation (2009-2014) but not mine (2010-2015).

Normally a recent dividend cut would be red flag for me.  But in this case shareholders would have been wise to hang on to shares after the cut given how quickly the annual dividend rebounded and continued to rise following the cut.  To me this rapid “make-up” shows strong commitment to paying shareholders.

One last point regarding the dividend growth rate.  VLO has gotten into the habit of raising its dividend twice per year in recent years.  This means that shareholders might be in store for yet another dividend increase this year!

While I’m not sure if a 50+% dividend growth rate is sustainable, VLO is certainly in a good position to continue their dividend increases.  Their dividend / EPS payout ratio is 0.17 and their dividend / FCF payout ratio is just 0.20.  VLO received a full point for the payout ratio parameter.

 

 

The recent > 5yr parameter is my rather crude way of measuring what I call dividend acceleration.  My assumption is that if the most recent dividend increase is greater than the 5-year average then the company may be ramping up their dividend payments.  The most recent increase (2014-2015) is 52% which just beats out the 51.6% 5-year growth, earning 0.5 points out of 0.5 for this parameter.  Keep in mind that the 2015 increase could be even more if we get a raise in August.

The final parameter to discuss from the dividend strength category is the dividend increase streak.  VLO has increased their annual dividend for 5 straight years which is good enough for 0.5 points out of 1.

 

VLO Financial Strength

VLO received a perfect 4 points out of 4 for this category.

Past 5-year earnings growth is an impressive 73% while analysts project 14% annual growth over the next 5 years.  Full point cutoffs are 20% for past 5 years earnings growth and 10% for future growth.

Debt / equity is a very reasonable 0.36 (less than 0.5 receives a full point) and the PE is only 8.1 (less than 20 receives a full point).  Long term debt has decreased every year since 2010.

One thing I’d like to add that is not part of my screen is that return on equity has increased from 12.1% to 18.4% from 2012-2014.  This shows that Valero is becoming more efficient each year.

 

Subjective Analysis

When I performed my VLO analysis, the stock price was 13.2% below the analyst consensus price target of $69/share.  I distribute points based on the standard deviation of percentages of all the stocks screened.  In this particular screen 13.2% was good enough to receive 0.75 points out of 1.

I should also point out that S&P Capital IQ has a $74 price target on VLO with a strong buy rating.

There were no positive indicators on the VLO chart so I did not award any points for the chart parameter.

 

Other Considerations and Risks

The migrations of crude oil inventories from the Midcontinent to the Gulf Coast will increase exports of refined products.  This should benefit VLO due to their high exposure to this region.

Valero also benefits from a more complex refining system than it’s competitors that allows them to process lower-quality feedstock into a high-value product.  This, along with their expanding rail-car fleet and enormous export capacity, provide a very wide economic moat.

Risks:

The major risks to oil & gas refiners are things that effect the spread between what the refiners pay for oil and how much they can sell the refined product for.  Therefore, things like supply interruptions or increased demand for oil will increase oil prices and have a negative impact on VLO.

Also, refining capacity is growing rapidly in Asia and the Middle East.  Without an increase in demand to offset this extra production Valero’s export capacity will no longer be an advantage.  Other risks include weaker economic conditions (a risk for most businesses) and additional increases in industry refining capacity.

I’m not too worried about oil prices going up just yet, and an economic slowdown that could decrease gas prices does not seem likely either.  I feel that the strengths of Valero Energy far outweigh the risks listed above.

 

VLO Purchase Details

• Sector: Energy
• Industry: Oil & Gas Refining
• Purchase date: 6/25/2015
• Portfolio: Dividend Retirement Portfolio
• Shares purchased: 43
• Cost per share: $60.4999
• Commissions: $14.95
• Cost basis: $2616.45
• Yield on cost: 2.63%
• Forward income: $68.80

My new VLO holding will bring in $68.80 of annual income to my portfolio, bringing the total up to $1731.76.  I took a slight hit on portfolio yield on cost but nothing a 50% dividend growth rate can’t fix.  My portfolio yield on cost is now 3.35%, down from 3.38%.

My Dividend Retirement portfolio has been updated to reflect the addition of 43 shares of VLO.

 

What are your thoughts on VLO?  What are you buying these days?  Please let me know in the comments section below!