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Here's Why You Should Retain Valero (VLO) in Your Portfolio

Valero Energy Corporation VLO is well-poised for growth on the back of a robust and diversified refinery base.

San Antonio, TX-based Valero is the largest independent refiner and marketer of petroleum products in the United States. The company with market cap of $39 billion has a refining capacity of 3.1 million barrels per day across 15 refineries located throughout the United States, Canada and the United Kingdom. The company’s earnings are expected to rise 8% within the next five years.

Courtesy of solid prospects, this Zacks Rank #3 (Hold) stock is worth holding on to at the moment.

Rationale Behind the Rally

Among all the independent refiners, Valero offers the most diversified refinery base with a capacity of 3.1 million barrels per day in its 15 refineries located throughout the United States, Canada and the Caribbean. More importantly, Valero is best placed to reap profits from solid refining margins, mainly owing to its strategic refinery structure that enables it to use cheaper oil for more than half of its needs.

Valero has been returning funds to its shareholders on a regular basis. Through third-quarter 2019, the company returned $679 million to its shareholders, of which $3.7 million was used to repurchase 3.9 million shares of its common stock and $372 million was paid out as dividends to its stockholders.

Notably, Valero forecasts capital expenditure for 2019 and 2020 to be $2.5 billion each. Around 40% of the budget will be used in growth projects. The company’s Pasadena terminal and St. Charles alkylation plus Pembroke cogeneration units are expected to come online in 2020. Moreover, its Diamond Green Diesel expansion and Port Arthur Coker projects are scheduled to be completed in 2021 and 2022, respectively. The growth projects are likely to boost the company’s cashflow.

Majority of the company’s refining plants are located at the Gulf coast area from where there is an easy access to the export facilities. This Gulf coast presence helped Valero expand its export volumes over the last few years and gain from high distillate margins. Moreover, Valero is poised to benefit from the new standard set by International Maritime Organization (IMO).

Per the standard, likely to be effective 2020, the proportion of sulfur in marine fuel will decline to 0.5% from the current 3.5%, thereby boosting demand for distillate fuel. Valero, being a producer of a significant amount of distillate fuel, is expected to capitalize on this.

The company is projected to benefit from the rising export volumes of refined petroleum products. This is because Valero has majority of its refining facilities in the U.S. Gulf Coast region. Notably, the company entered into long-term accords to utilize three new refined product terminals in Mexico. The leading refining player will be able to expand its product supply chain once the Guadalajara, Monterrey and Altamira terminals commence operations in 2021.

Headwinds

However, there are a few factors that are impeding the stock’s growth lately.

In a bid to lower greenhouse gas emissions, Energy Information Administration (EPA) set a Renewable Fuel Standard. Per the new mandate, refiners need to add year-over-year higher volumes of advanced biofuels to gasoline through 2019. Following this, Valero will be compelled to divert cash to ensure regulatory compliance, which can limit profitability. This is also likely to lead to the refiner incurring higher biofuel blending costs this year.

The slowdown in the global economic growth is likely to hurt demand for refined petroleum products. Being one of the largest refiners in North America with refining contributing the most among all operating segments, weak refined petroleum products’ demand is anticipated to drain the company’s profit and contract total throughput volumes.

The gasoline crack spread has significantly narrowed recently, denting the company’s bottom line. Moreover, the spike in corn price has been ailing the refiner’s ethanol business. In the third quarter, the company’s Ethanol segment suffered an operating loss of $43 million against a profit of $21 million in the year-ago quarter due to steeper corn prices.

Wrapping Up

Despite substantial prospects mentioned above, higher corn prices and sluggish global economic growth are concerns for the company. Nevertheless, we believe that a systematic and strategic plan of action will fuel its long-term growth

Key Picks

Some better-ranked stocks in the energy sector are CNX Resources Corp. CNX, Antero Midstream Corp. AM and Frank's International N.V. FI, each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

CNX Resources’ earnings for the current year have witnessed four upward revisions in the past 60 days while there was no movement in the opposite direction.

Antero Midstream’s bottom line for the current quarter is envisioned to skyrocket 130% year over year.

Frank's International’s bottom line for 2019 is expected to rise 23.8% year over year.

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