Getting into Oil with VLO

Source: https://mriqd.com/oil-man/

Source: https://mriqd.com/oil-man/

Well it probably can't come as much of a shock to everyone when I say that I don't know much about the oil business. The most that I can tell you when it comes to oil is the current price of gas, that my V8 isn't efficient, and that companies that have been getting crushed since late 2015 are finally making their way back towards those levels. That are typically the how cyclical industries work so really no surprise there either. As the first quarter ended though I realized that I had a huge deficit in my diversification, in the form of nothing from the basic materials industry.

All that ended today though, when I purchased some shares of Valero Energy Corporation (VLO).

A quick mandatory snippet about Valero:

Valero Energy Corp. is a petroleum refining and marketing company. The Company produces conventional gasolines, distillates, jet fuel, asphalt, petrochemicals, lubricants, and other refined products as well as a slate of premium products.

Valero Energy is the largest independent refiner in the United States. It operates 14 refineries with a total throughput capacity of 3.1 million barrels a day in the United States, Canada, and the United Kingdom. Valero also produces 1.3 billion gallons of ethanol a year, and it owns a 68% interest, including the general-partner interest, in Valero Energy Partners LP.

--Taken from Gurufocus.com

 

Why would I buy a company that I know very little about (in terms of industry) when all I do is preach about research? One word: Diversification.

While I need diversification in my portfolio don't go thinking that I just bought VLO on a whim without looking into their background and digging through some 10k's and breaking down a lot of fundamentals. There are some things that I always begin my screens with when I go to invest at the 15th and 30th each month. These are the following:

  1. Price to Earnings Ratio of <15
  2. Current Ratio of >2
  3. Quick Ratio of >1
  4. Dividend Yield >3%
  5. Payout Ratio <60%
  6. Price >$10

This screen today returned 9 different companies. Of the 9 companies that it returned I actually already own 3 of them (CSS Industries, Inc., Gilead Sciences, Inc., Sturm, Ruger, & Company, Inc. What was narrowed to 6 now held only one company in the Basic Materials industry, Valero Energy Corp.

The Fundamental Showdown

Valero currently sits at just 7% off the 52 week high it hit in early 2017 and has been trading in a fairly tight channel since that time. With a current price to earnings of just over 14 it sits as the 3rd lowest P/E refiner behind Tesoro Corporation and China's Sinopec Shanghai Petrochemical Company Limited. 

When I compared these three Valero and Tesoro were the only ones that passed both the current and quick ratio screen. My next question, especially in times of potential rate hikes, is about interest coverage ratio, which Valero wins at double the current ratio of Tesoro. 

So Anything Else?

Okay so Valero won a fight that really didn't contain a ton of players and to be honest the industry has had quite a boost since last summer. Now looking at oil (remember I do this very broadly as I am not an expert) I see an industry that may take awhile to see the outrageous crude prices of the past. If it never gets there then why would I hold this company?

IMAGE SOURCE: VALERO ENERGY INVESTOR PRESENTATION.

IMAGE SOURCE: VALERO ENERGY INVESTOR PRESENTATION.

  • Dividend Yield/Growth -
    • Valero's dividend is currently at a staggering 4.25%. This with a payout under 60% and a growth on average of ~41% over the past three years means that not only is there still room to grow but there is a definite push from the company to do so. This, mi amigos, I really like.
       
  • Buybacks - 
    • Over the past year, the company has again drastically reduced the share count (>7%) and since 2011 it has slashed them by over 100 million! Talk about rewarding shareholders. This tells me that even if the company doesn't want to increase dividend at the frantic pace it has been at least I can look forward to EPS delivering because of reduced share count.
       
  • Potential for Growth -
    • While this may seem a bit odd in what could be an industry that some see as nearing a critical point where clean energy will continue to take market share, it seems that Valero has other plans. They announced in their Q1 report that they are still on track to invest over $2.7 billion in of total capital, of which $1.1 billion will be for "growth projects". What these projects are remain to be seen but it is never a bad thing to see a company setting aside money to try to continue their growth.

 

The Final Scoop

To wrap it up, I believe that I have made a very nice acquisition in an industry that was very much lacking in my portfolio. While I know that I will probably get scrutinized about buying towards the 52 week high I am not at all worried as it will be held for years and years and if it declines will be added. Add to that a dividend of over 4% and a payout ratio that spells not only future growth but also continued buybacks, I believe that this investment will end up with a great return by 2020 if not much, much sooner.