Refiners' Second Take: Valero's Risk of Irreparable Harm (VLO, MRO, HES, TSO, SUN, TOT, VSUNQ)

Valero Energy Corp. (NYSE: VLO) may have caused some irreparable harm to itself and to shareholders this week.  Losing money is just not something that the investing public was ready to stomach.  Dumping news of a large secondary offering right on top of projecting a loss was no different than pouring salt and peroxide on your kid’s cut hand when he wasn’t looking.  This has added pressure on other refiners such as Marathon Oil Corporation (NYSE: MRO), Hess Corporation (NYSE: HES), Tesoro Corporation (NYSE: TSO), and Sunoco Inc. (NYSE: SUN).  Valero has always had what always looked like a dirt cheap price to earnings ratio, and now you know why.  This may have put some serious future questions on the sector, even if much of this news is company-specific.

Marathon Oil Corporation (NYSE: MRO) shares are down about 6% after Valero’s news this week. Hess Corporation (NYSE: HES) did better than most with a mere 2% decline after Valero’s drop.  Tesoro Corporation (NYSE: TSO) took more than a 10% hit before shares recovered 4% today. Despite a 2% gain today, Sunoco Inc. (NYSE: SUN) is down almost 4% in the last two sessions.

After looking through the projected loss at Valero, this is not just an asterisk.  Valero’s -$0.50 EPS forecast was largely due to extended downtime at its Delaware City and McKee refineries and the continuation of weak sour crude oil discounts along with lower diesel margins.  The company’s Port Arthur project has been put on indefinite hold.  Valero’s total cap-ex budget for 2009 is now approximately $2.5 billion, with close to $1 billion for strategic projects and acquisitions.

The only good news about the secondary offering is that the company priced its 40 million shares at $18.00 per share.  That is of no comfort to those who owned Valero north of $22.00 just 48 hours ago.  But it is at least enough of a discount that it enticed new buyers.  While it was obvious that a bigger cash buffer would have helped, this was just not exactly the best way to treat shareholders.

Deutsche Bank’s energy analyst in late May also noted that Valero’s price tag for buying a stake in Total SA (NYSE: TOT) was way too high for the its 45% stake in Total Raffinaderij Nederland refinery.   Our own opinion of the acquisition of $477 million in ethanol plants from VeraSun Energy Corporation (OTCBB: VSUNQ) is not exactly a favorable one.  Just yesterday it was BMO that cut its rating on Valero down to an “Underperform” due to this disappointment.

Even after this offering, the company is still leveraged.   That may come down if the company gets back to profitability and if it pays down more debt rather than keep making acquisitions.  Maybe it is time for Valero to review more refinery sales.  If not, you could argue that added share sales could come down the pipe.  And how will that make shareholders feel?

Valero’s 52-week trading range is $13.94 to $52.86, and this was flirting with prices close to $80.00 about two-years ago. Its current and forward P/E ratio are just about always well under 10.  Again, now you know why.  When rising oil prices and  falling oil prices both negatively impact your business, traders and investors alike are likely to just stick to companies whose shares will move in the same direction as oil.

In a sense, this exchange here starts to seem more and more like a guy that wants to marry a stripper.  There is probably going to be some baggage and some serious damage control, and the upside seems questionable.  Jim Cramer even added Valero’s CEO to the wall of shame after this double-dip of news here.

Valero almost always makes the big screens for value investors.  That is now looking more  like a classic value trap.  Unfortunately, this may keep a bit of dark cloud over the other big refiners for a while, even if other oil stocks manage to do well.    The damage is likely not permanent for the sector.  How investors treat Valero compared to peers may be another issue entirely.

Jon C. Ogg
June 4, 2009