Insights

Is Valero a Buy Now?

Summer is here. And if you’re like me, that means road trips with the family. But this year’s summer vacation may come with some sticker shock. AAA reports that the national average for a gallon of gas is $5.01. In Illinois, Nevada, and Oregon, you should expect to pay over $5.50. And in California, buckle up because the average price in the Golden State is $6.43 per gallon.

Obviously, higher prices for crude oil are behind much of the surge in prices. But so is the lack of refinery capacity. So, is now the time to buy Valero Energy Corporation (NYSE: VLO)? Let’s dig in and see.

Refinery utilization is up, and overall capacity is down

Refiners take crude oil and produce petrochemical derivatives, such as transportation fuel. Since most of their end product is gasoline, diesel, and aviation fuel, refiners were particularly hard-hit by the pandemic. As countries locked down, cars and planes sat idle, and fuel reserves surged. Refineries lowered their production; many closed for good. In 2021, U.S. refinery capacity fell for the first time in a decade. 

US Oil Refinery Capacities data by YCharts

This drop took the U.S. back to 2015-2016 capacity levels. However, the refining industry is now experiencing a severe case of whiplash. Gas, diesel, and fuel demand have increased over the last 12 months as pandemic restrictions have eased and travel has largely returned to pre-pandemic levels. Refiners have ramped up, causing U.S. refinery utilization to skyrocket to 94.2% — well above the long-term average of 88.9%. In short, there simply aren’t enough refineries to keep up with the demand. 

U.S. Utilization of Refinery Capacity data by YCharts

But what about the rest of the world? Could international refiners pick up the slack and help relieve some of the strain on U.S. refiners? Well, three countries are responsible for over 40% of worldwide refining capacity: the United States (19%), China (16%), and Russia (7%). 

Some Chinese refineries have cut production due to COVID-19 restrictions. Moreover, China has implemented export caps on refined products, making it unlikely that China can ramp up supply in the near term.

As for Russia, international sanctions prohibit many countries from importing refined products from Russia. It’s believed that Russia has cut its refinery production by over 30% this year.

What does this mean for Valero? 

In short, tight demand is excellent news for Valero and refiners in general. With no slack in the system, Valero can raise its prices and grow its margins. The company’s trailing-12-month (TTM) operating margin swelled to 3.2%, which is up from a pandemic-induced low of (2.3)%. Moreover, quarterly year-over-year revenue growth stands at 85.2%, and overall revenues (TTM) have climbed to $131.7 billion, the highest levels since 2015.

So, things look good for Valero right now. But what about the future? Could additional capacity come online to ease the current bottleneck? Well, there’s no real sign of that happening anytime soon. In fact, the crunch might be getting worse. Valero’s own Chief Commercial Officer, Gary Simmons, was recently quoted by Reuters, “It’s hard to see that refinery utilization can increase much. We’ve been at this 93% utilization; generally, you can’t sustain [that level] for long periods of time.”

That might be bad news for drivers, but it’s fantastic news for Valero investors. Barring a recession that crushes energy demand, the company should maintain strong operating margins. And with a forward price-to-earnings ratio of only 10.9 and a dividend yield of 2.9%, I think Valero is a safe place to hide in a bear market.

Jake Lerch has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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