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Krause Fund Research
Fall 2018
Energy Recommendation:
Analysts
Andrew Ball
Samuel Bries
Adam Goedken
Gregory Hensley
Company Overview
Valero Energy Corporation is both a midstream and
downstream energy company that operates by refining and
marketing oil and other fuels. Valero operates refineries
both in North America and in Europe. Outside of refineries,
Valero has more than 1,000 branded gas stations worldwide.
Valero is based in San Antonio, Texas and is in the process
of solely acquiring their transportation segment of their
operations. By attaining sole ownership of their
transportation segment, Valero expects to increase
companywide revenues.
Stock Performance Highlights 52 week High $126.98
52 week Low $80.00
Beta Value 0.91
Average Daily Volume 3.432 m
Share Highlights Market Capitalization $36.478 b
Shares Outstanding 424.31 m
EPS (2017) $9.17
P/E Ratio 8.28
Dividend Yield 3.65%
Dividend Payout Ratio 30.53%
Company Performance Highlights ROA 8.44%
ROE 18.58%
Sales $93.980 b
Financial Ratios Current Ratio 1.74
Debt to Equity 1.19
Valero Energy Corporation (NYSE: VLO)
November 11, 2018
Current Price $85.97
Target Price $114-$118
Favorable Throughput and Margins
Will Propel VLO Above Expectations
Investment Positives
• Valero achieved maximum capacity in Q3 of 2018,
operating at 99% utilization, which represents throughput
volumes of 3.1 million barrels of oil per day. We project Valero
to achieve a high efficiency level of 83% utilization on the year,
and to improve utilization in the following years.
• Valero’s crack spread increased from $10.90 in 2016 to
$11.65 in 2017, and we project it to reach $12.18 in 2018. Due
to these more favorable margins, Valero saw a year-over-year
jump in revenues of 31% to $30.8 billion in 2017.
• Valero estimates that they will spend $2.7 billion on capital
expenditures, with $1 billion of that being used for growth
products. As Valero invests more back into growth of its
operations, they will reap the benefits of economies of scale.
Investment Negatives
• Valero’s net operating income is reliant on crack spreads,
which are difficult to forecast accurately. A disappointing crack
spread could make a large difference in the intrinsic value of
Valero’s stock.
• Valero has a relatively high debt-to-equity ratio of 1.19,
compared to the average of its peers of 0.86. As the Federal
Reserve continues to raise interest rates to hedge against rising
inflation, Valero might find itself in an uncomfortable, less
flexible position for investing back into its operations.
One Year Stock Performance VLO one year stock performance relative to the S&P 500 Index
and the U.S Energy Select Sector SPDR Fund
Source: Wall Street Journal 1
BUY
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Macroeconomic Outlook
Executive Summary
As of November 11, 2018 our University of Iowa Krause Fund
analyst team recommends a BUY rating for Valero Energy
Corporation. Valero has been operating at a high level of
efficiency for the past year, and is expected to achieve higher
utilization in the coming years. These levels of efficiency,
combined with a favorable outlook for oil crack spreads, will
guide the company to achieve higher earnings. Due to active and
optimistic customers in the global marketplace, the
macroeconomic environment looks bright for oil and gas
refining and marketing companies, such as Valero.
Unpredictable risks, like natural disasters, can impact Valero’s
utilization numbers and crack spreads, both of which drive the
company’s bottom line. However, the company is less
vulnerable to changes in oil prices than integrated or upstream
energy companies, due to Valero’s diversified midstream and
downstream operations. Ultimately, we found Valero Energy
Corporation’s investment positives to be greater than its
potential risks, leading us to identify Valero stock as
undervalued.
World Real Gross Domestic Product (GDP)
Real Gross Domestic Product (GDP) is one of the key indicators
of economic development that influences the demand for oil and
other energy resources. Economic expansion occurs when the
demand for goods and services increase. In an economic
expansion, sales of products for which oil and natural gas are
inputs increase, and consumers are less frugal with their energy
consumption. Businesses look to grow, requiring more energy
consumption than before. Consequently, real GDP growth
increases demand for energy resources, leading oil prices to rise,
driving revenue growth. Figure 1 shows a correlation between
economic growth and oil demand and consumption.
Figure 1
Source: U.S. Energy Information Administration2
Domestic Growth Outlook
Healthy domestic growth will be a positive for energy
companies in the U.S. The U.S. economy grew 4.2% and 3.5%
in the second and third quarters of 2018, respectively, a large
increase from 3.1% and 3.2% growth in the second and third
quarters of 2017. Strong consumer and business spending are the
two primary factors that have helped drive the strong economic
growth in the past two quarters.3 According to the Federal
Reserve Bank of Atlanta, U.S GDP growth is expected to be
2.9% in the fourth quarter of 2018.4
Figure 2
Source: FRED Economic Data3
In the next year, we predict that U.S real GDP growth will grow
at a rate of 3.0%, a 70-basis-point increase from an annualized
growth rate of 2.3% from 2017. The Tax Cuts and Jobs Act of
2017 has contributed to large corporate profits and business
investment in the last year. The Commerce Department noted
that after-tax profits across the U.S rose 16.1% in the 2nd quarter
from the previous year, the largest year-over-year gain in six
years.5 As a result, per-share earnings for companies in the S&P
500 rose 24.8% over the second quarter of 2017.
Figure 3
Source: Wall Street Journal5
In addition to rising corporate profits and business investment,
metrics such as consumer confidence, rising personal income, a
strong labor market, and a jobless rate of 3.7%, has encouraged
greater consumer and business consumption that has driven
economic expansion. Figure 4 shows the U.S. Consumer
Confidence level directed by the Conference Board Consumer
Confidence, which current levels show at 98.3.6 Given that
consumer confidence is measured based on household surveys of
consumers’ opinions on current conditions and future
expectations of the economy, we expect this trend to continue.
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Given these metrics, we expect U.S. GDP to grow at 3.00% for
the foreseeable future.
Figure 4
Source: Trading Economics6
International Growth Outlook
For our analysis of the international marketplace, we consider
China and India to be the main foreign drivers for energy
resources. China and India together contribute nearly 50% of
global oil demand.7 Figure 5, below, shows world oil demand
growth by year, showing China and India’s dominance for the
demand of oil.
Figure 5
Source: International Energy Agency7
The International Monetary Fund has projected global GDP to
grow at 3.7% for 2018 and 2019, with China and India’s GDP
expected growth rates to be 6.20% and 7.70%, respectively.8 As
China and India continue to expand their economies and
international footprint, they will use more oil, which will drive
oil demand and consumption higher. Future curves project that
oil prices will reach $60.06 in 2022.
Figure 6
Source: International Monetary Fund8
With an expected 3.7% world GDP growth rate for 2018 and
2019, the international marketplace will be a significant driver
for energy demand and consumption. Energy demand and
consumption will not only come from larger economies such as
China and India, but also emerging markets and developing
countries benefiting from overall world growth, and a positive
rotation in the global business cycle.9
Figure 7
Source: International Monetary Fund8
Interest Rates
Interest rates are a key economic variable to consider as they are
one of the major determinants of a firm's cost of debt. Rising
interest rates lead to higher borrowing costs, as investors require
a higher return for riskier investments taken by the firm. The 10-
Treasury Yield (3.186%) was used as the risk free rate to
calculate the cost of debt in our valuation. Figure 8 shows that
the 10-Treasury yield has been rising steadily over the past year
with oil prices. Due to the recent hikes in the federal funds rate,
we expect the rate to reach 4.00% by 2020 to trump rising
inflation.
Figure 8
Source: FRED Economics Data10
As of September of 2018, Federal Reserve officials have raised
interest rates for the third time this year and have reaffirmed
their outlook for further rate hikes into 2019.11 The federal funds
rate currently stands at 2.25%, a 25 basis-point increase in
September from its last rate of 2.00%.
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Figure 9
Source: Bloomberg11
Oil exploration and production companies are often highly
leveraged, as they look to expand their operations by acquiring
more reserves. As the federal funds rate is projected to increase
three times during 2019, firms with a low cost of debt that have
a history of paying back their lenders—like Valero—are able to
maneuver better in this environment.
Energy Commodities Supply & Demand
For energy commodities, supply and demand is the definitive
driver of price. Oil and gas prices fluctuate due to supply and
demand of the commodity. If prices are high, energy companies
are more likely to produce more, and vice versa. Upstream
companies benefit the most from high oil prices, while
midstream and downstream companies benefit less, though these
companies are still impacted by oil prices. Oil prices increase as
oil demand increases. Oil demand is determined by
consumption. The oil production of OPEC and non-OPEC
countries influence the supply of oil greatly. Figure 10 shows
how changes in the oil production of Saudi Arabia, an OPEC
country, can influence WTI crude oil prices. OPEC’s oil exports
represent about 60% of the total petroleum traded
internationally, producing 0.3 million barrels per day in quarter 3
of 2018, its largest production amount in over a year.12
Figure 10
Source: U.S. Energy Information Administration12
In 2017, world oil production rose by 0.6 million b/d, below
average for the second consecutive year. Production fell in the
Middle East (-250,000 b/d) and South & Central America (-
240,000 Kb/d), but this was outweighed by growth in North
America (820.00 b/d), specifically the U.S. (690,000 b/d).13
Figure 11
Source: U.S. Energy Information Administration14
Figure 11 provides the growth U.S. production of crude oil,
showing a steep increase since the financial crisis of 2008. In
2017, global natural gas production increased by 4% - the fastest
rate since the immediate aftermath of the financial crisis15.
Figure 12 shows the growth of natural gas production in the
world. Recently the U.S. has begun increasing production of oil
and natural gas as they work to become more energy
independent.
Figure 12
Source: BP Global Report15
OPEC as a Geopolitical Player
Beyond world GDP and energy commodity supply/demand,
geopolitics also influences the price of oil. One major player in
the geopolitics of the supply and demand, and ultimately the
price of oil, is OPEC. OPEC’s stated mission is to provide
regular supply, stable markets and a fair return on investments to
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Industry Analysis
investors. While OPEC does not control the price of oil, they
play a big part in it. By restricting oil production and slashing oil
supplies, OPEC could force oil prices to rise, benefiting net
exporters of oil, but hurting large importers of oil, such as China.
Figure 13
Source: OPEC Annual Statistical Bulletin 201816.
As the U.S. looks to become more energy independent, the EIA
projects that the United States will become a net energy exporter
by 2020, primarily driven by higher oil prices and technology
and a reduction in regulation within the oil and gas exploration
industry.17
Figure 14
Source: U.S. Energy Information Administration17
Overview
The oil and gas industry has three main parts: upstream,
midstream, and downstream. Upstream firms operate by
exploring for oil and producing oil. Revenues are largely driven
by the market price of oil. Mid-stream firms operate by storing
and transporting oil, natural gas liquids (NGLs), and other
natural gases. Mid-stream firms operate as a middle man
between upstream and downstream firms. Downstream firms
operate by refining oil, NGLS, and natural gases into
consumable products, as well as marketing the finished products.
Valero is considered an oil and gas refining and marketing
company, operating in the midstream and downstream segments
of the oil and gas industry. Income is largely driven by a “crack
spread”, which is the difference between the cost of materials
and the revenues received from selling the finished energy
products.
Refining companies “crack” crude oil apart in refineries,
producing different products, such as gasoline, jet fuel, and
diesel. Figure 15 shows a simplified version of how the oil
refining process works.
Figure 15
Source: CME Group.18
Another component of revenue for some oil and gas refining and
marketing companies, including Valero, is production of
ethanol.
Developments and Trends
Global oil production and consumption is expected to continue
rising for the foreseeable future. The United States is becoming
more energy independent, which makes OPEC less of a driver
oil prices domestically. Recently, we have seen large growth in
the natural gas production industry that has outpaced demand for
natural gases. This large gap between supply and demand has
caused natural gas prices to drop substantially in recent years.
Figure 16
Source: International Energy Agency19
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Company Analysis
Industry Leaders
All of the largest firms in the oil and gas industry are integrated
oil firms, which means they operate across all three production
streams. Exxon Mobil and British Petroleum are among the
largest firms in the industry.
Exxon Mobil – Exxon Mobil Corporation is an American
multinational oil and gas corporation. Exxon Mobil is the largest
of the world’s big oil companies, with daily production of 3.921
million BOE.20 The company is the world’s 9th largest company
listed by revenue.
British Petroleum – The British Petroleum Company plc, or BP
plc, is a British multinational oil and gas company. BP is one of
the world’s seven oil and gas “supermajors”. As of 2017, BP has
operations in 70 countries worldwide and produced around 3.6
million barrels per day.21
Industry leaders are able to operate at low costs relative to their
competitors and are not solely reliant on crack spreads or the
price of oil to stay profitable. Leaders often implement
derivative trading along with their operations to profit off of
trends in the oil and gas industry. Followers in the oil and gas
industry are often unable to produce energy products cheaply,
and are reliant on high oil prices or crack spreads to remain
profitable. These follower companies often have high levels of
debt, and experience cash flow issues when oil prices dip below
desirable levels. Valero is a mid-size company that does not
operate upstream, so they are steadier and safer than many
smaller oil and gas companies, however, they typically do not
reap the same benefits as the large industry leaders.
Porter’s Five Forces Analysis
Threat of New Entrants
While there is some disparity in level of risk and flexibility,
large established companies and smaller newer companies can
both compete in this space. Larger companies are usually more
profitable due to larger refineries and access to resources while
smaller companies must focus more on efficiency to compete.
Valero is one of the largest oil refining companies in the
international marketplace, leading them to focus on expansion to
achieve greater economies of scale. Threat of Substitutes New developments in renewable energy are a direct threat to the
demand of fossil fuels in the long-term. The rise of all-electric
cars could potentially cause a drastic reduction in global oil
demand. Bargaining Power of Suppliers Individual firms do not dictate crack spreads or the price of oil
and gas. Overall, production in the industry affects supply,
which in return affects commodity prices. Bargaining Power of Buyers Buyers are institutions and consumers that use refined oil
products. They can negotiate some of the price that they pay, but
price is mainly decided by market price of the commodity
purchased. Rivalry Among Competitors Large companies simply have greater throughput capacity than
smaller ones. Companies are constantly fighting to be the
lowest-cost producer or to find ways to increase utilization.
Financial Summary Analysis
In fiscal year 2017, Valero reported revenues of $93.98 billion,
representing growth of 24% from 2016. Drivers of this revenue
increase were largely a 21% increase in gasoline revenues and a
31% increase in distillate revenue. We estimated Valero’s crack
spread to have increased from $10.90 per barrel in 2016 to
$11.65 in 2017. An increase in crack spread is a positive for
Valero because it means they are able to operate at a higher
profit margin while producing the same product.20
Valero saw an increase in their ending cash account for 2017 of
approximately $1,034 million.20 We believe that almost all of
this increase in the balance is attributable to the income tax
benefit that Valero received for the year.
On October 25, 2018, Valero released a bright Q3 earnings
report. Valero saw a year-over-year jump in revenues of 31% to
$30.8 billion.21 Valero was able to achieved a 99% utilization of
their refinery plants, which we believe is the maximum
utilization a refining plant is able to have. 99% utilization
represents throughput volumes of 3.1 million barrels of oil per
day over the entire year.21 Valero did see a decrease in Q3
operating income of $100 million, but Valero states that the
decrease is due to lower margins on gasoline and secondary
products. On the year, Valero will likely have utilization of
around 83% and a slightly higher crack spread than fiscal year
2017. For fiscal year 2018, Valero is estimating that they will
spend $2.7 billion on capital expenditures, with $1 billion of that
being used for growth products.21 $975 million of the $1B in
growth projects is expected to go towards construction of a
recently-announced refinery in Port Arthur, Texas.21 This
project, not included in our models, is expected to reduce
refining feedstock costs and increase throughput capacity, which
we expect to grow revenues. Products
Valero uses refining operations to produce gasoline, diesel fuel,
and other petroleum fuels, such as jet fuel. Valero also licenses
their name out to independent gas stations. Valero-branded gas
stations include Valero, Beacon, Diamond Shamrock, and
Shamrock. Along with production operations, Valero operates several
pipelines through the transportation segment of their operations,
Valero Energy Partners (VLP). Valero recently acquired VLP.
Previously, Valero’s relationship to VLP was through a master
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limited partnership, a structure that created tax benefits for
Valero. Recently, the industry has shifted away from this type of
partnership, favoring operational simplicity, and Valero’s
purchase of VLP follows this trend. Valero Energy Corporation
bought Valero Energy Partners at a price of $42.25, for a 12.4%
premium. The market reacted negatively to the news; VLO stock
dropped from $103.37 to $94.13 when the news was announced.
VLO’s merger with VLP is not included in our models. Production
Valero’s operations are spread across 15 refineries and
production facilities across the United States. Of the 15
locations, seven are located in the US Gulf Coast.20 We have
highlighted these regions as being potentially at risk to weather
events, particularly hurricanes. Major hurricanes in the Gulf
region could have significant impacts on revenues given the high
concentration in the vulnerable region. Total production in the
Gulf region accounts for 58% of Valero’s total production. Other
facilities in North America include Tennessee and Oklahoma.
Valero does have an international presence with facilities in
Canada and the United Kingdom. Production at these two
international locations represents approximately 17% of total
energy production. Valero’s profit is derived from production
volumes and the crack spread on their energy products. The
crack spread in 2017 was $11.65. Yearly crack spreads are
difficult to predict. Spreads are generally cyclical throughout the
year, as demand for products, such as heating oil, rises and falls
with the seasons, and weather events impact supply and demand. Markets and Customers
Due to their operations as an oil and gas refining and marketing
company, Valero acts as both a producer and a middle man.
Valero sells oil in both wholesale rack and bulk. Wholesale rack
customers include Valero-branded gas stations (Valero, Beacon,
Diamond Shamrock, Shamrock) and non-Valero gas stations
with contractual agreements to purchase wholesale oil and
diesel. Contracts with wholesale buyers allow Valero to have
low transportation costs, and more importantly gives Valero a
steady demand for their products. As a bulk seller, Valero
distributes crude oil to refineries and refined products, such as
jet fuel, to consumers.
Competition
Overview Valero operates within the refining and marketing sub-industry
of the energy sector. We identified competitors with refining and
marketing operations that are not exclusively in this subindustry.
Another variable we took into consideration is where operations
are taking place, as the type of crude oil is being refined is
important. We decided to select competitors that have a large
presence in Texas. We decided to look at the ROA, net profit
margin, and debt-to-equity ratio as a way to compare these
competitors.
Figure 17
Source: Phillips 66 Form 10-K22
Phillips 66 is a diversified energy manufacturing and logistics
company with businesses in refining, midstream, chemicals and
marketing, and specialties. Phillips 66 is comparable to Valero
because of their operations in the refining and marketing
industry. The ratio comparison shows Valero lagging in all
categories to Phillips 66, as ROA and net profit margin is
lagging around 1%.22 Debt-to-equity is best represented in this
comparison, as Valero has a high ratio, but is close to a complete
substitute. Figure 18
Source: Exxon Mobil Form 10-K23
Exxon Mobil is the largest publicly-traded oil and gas company
in the world. Exxon is a major integrated oil and gas company,
which means that Exxon operates in the entire process of
obtaining the commodity and selling it to customers. Exxon and
Valero share the same operations in the refining and marketing
part of the business, but Valero does not have an exploration and
drilling part of the business. The ratio shows that Valero
outperforms Exxon Mobil in ROA, while Exxon Mobil
outperforms when considering net profit margin.23 However, this
may due to the different operating segments.
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Valuation Analysis Figure 19
Source: HollyFrontier Corporation Form 10-K24
HollyFrontier Corporation (HFC) is an independent petroleum
refiner in the United States. HFC produces and markets a wide
variety of petroleum products such as gasoline, lubricants, and
jet fuel. HFC operates in similar operation lines, such as
marketing and the refining process. The ratio comparison is
similar to Exxon Mobil, as Valero outperforms in ROA, but lags
in net profit margin.24
SWOT Analysis Strengths Valero has a more diverse business model than other companies
in the sector because of their partially integrated structure.
Valero is not solely reliant on refining, as pure refining
companies are, allowing them to remain profitable when the
price of oil is volatile. Weaknesses Valero operates in areas that are vulnerable to weather events. In
2017, Hurricane Harvey caused Valero to lose 6% of their daily
refining output for the entire quarter (Q3 Earnings). As climate
change causes weather events to be more severe, Valero could
see larger drops in output due to storms if they do not begin
investing in areas safe from hurricanes. Opportunities Valero’s international presence could lead to contracts with gas
stations located outside of the United States. Diversifying across
international borders could allow Valero to become a global
force after the model of Exxon Mobil. Threats 77% of all transportation energy in the United States is from oil
and gas distillates, with a large consumer of this energy being
automobiles. With the innovation being observed in the auto
industry, Valero is threatened by the rise of electric vehicles.
Adoption of electric vehicles would hurt Valero on the
production side, but also affect their revenues received from
contracts with gas stations.
Overview
Our analyses of the macro economy and the oil and gas refining
and marketing industry informed the models that ultimately led
us to a BUY rating for Valero Energy Corporation. We based
our valuation off the DCF/EP model, which included our
forecasts for key company line items and characteristics. The
model is strongly reliant on the margins Valero faces and
Valero’s success in increasing production through greater
efficiency. Based on the company’s past performance and
projected future earnings and growth, we believe Valero’s stock
is undervalued. Revenue Decomposition
Gasoline and Blendstocks
We calculated sales of gasoline and blendstocks by multiplying
refining segment throughput volume by an annualized price per
barrel of oil equivalent (BOE). Crude oil futures for December
of each forecasted year determined projected refining revenue
per barrel. We forecasted volume by holding capacity constant
while incrementally increasing utilization from 83% in 2018 to
93% in 2022. Consistent historical yearly utilization
improvements informed our decision on how to project
utilization. Distillates and Other Refining We based future distillates and “other” refining revenue off a
constant ratio. Barrels of oil are “cracked open”, producing
consistent ratios of gasoline to other distillates (see Figure 20).
Valero’s distillates and “other” refining sales have, on average,
been approximately 18% higher than sales of gasoline and
blendstocks in the past. That ratio was what we used in our
calculation of future distillates and “other” refining revenue.
Figure 20
Source: U.S. Energy Information Administration25
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Ethanol Ethanol revenues are the product of ethanol revenue per gallon
and ethanol production volumes. We held revenue per gallon
constant at the average price of the previous three years: $2.00.
We made this decision based off past prices per gallon, which
showed no trends, and fluctuated little. We applied a steady
growth rate when forecasting production volumes, since past
years’ volume figures showed a consistent, positive trend. Other Ethanol We forecasted “other” ethanol revenues to slightly decrease.
“Other” ethanol revenues represent sales of distillers’ grain,
which is sold as feed for livestock. Lower prices due to
decreased export demand for distillers’ grain have driven a
steady decline in “other” ethanol revenues in recent years, which
we projected out into the future using the average negative
growth rate of the past three years. Costs
Cost of Materials Cost of materials was based on our crack spread estimation. To
calculate this figure, we used the equation:
Crack spread = revenue/volume - cost/volume
To estimate cost, we first weighted the ethanol and refining
segments by revenue, then multiplied those weights by total
estimated cost of materials (which was calculated using an
average ratio of past cost of materials to volume).
2018 Cost=
+
Finally, to make cost of materials a function of the crack spread,
we multiplied the spread by volume, then subtracted from sales.
To avoid an outsize impact on future crack spreads from price
estimates, we applied an average growth rate to COGS after the
first forecasted year. The impact of this assumption can be
observed in our sensitivity analysis. Operating and General and Administrative Expenses We held operating and general and administrative expenses
constant, as we expect prices related to increases in production
activity to be offset by more cost-efficient production.
Production efficiencies will likely be improved through
modernization or expansion of existing refineries; for example,
in 2017, Valero invested in a cost-lowering cogeneration unit at
their Wilmington refinery. WACC
We estimated Valero’s WACC to be 7.09%. We used this
WACC for all years in the future because we do not expect
Valero’s capital structure to change in the future. To calculate
WACC, we applied weights of 71% to equity and 29% to debt
based on market value, before multiplying those weights by cost
of equity and cost of debt, respectively. Cost of Equity
To calculate cost of equity, we applied the Capital Asset Pricing
Model (CAPM) and calculated the cost of equity to be 8.027%.
Our variables used in the CAPM are as follows:
• Risk Free Rate = 3.186%
• Equity Risk Premium = 5.32%
• Beta = 0.91
Our risk free rate represents the yield on the 10-year U.S.
Treasury as of November 11, 2018.26 The equity risk premium
was given by Damodaran’s implied ERP on November 1,
2018.27 We believe that this number accurately represents the
geometric average of our expected market risk premium. Our
beta was calculated by taking the average of the 2 year raw betas
calculated daily, weekly, and monthly on Bloomberg. Cost of Debt
To calculate Valero’s cost of debt, we used the yield on a Valero
corporate bond maturing in 10 years. We found the yield to be
4.41% on SEC’s EDGAR database.28 To find the after-tax cost
of debt to be used in our cost of capital calculation, we took the
yield on the 10-year corporate bond and then adjusted it to
reflect the marginal tax rate of 21% due to the new tax plan. This
calculation gave us an after-tax cost of debt of 3.49%. Valuation Models
We used a discounted cash flow/economic profit (DCF/EP)
model, a dividend discount model, (DDM), and a relative
valuation to analyze Valero’s stock value. Ultimately, we
decided the DCF/EP model represented the most complete and
accurate valuation for Valero. Results
DCF/EP DDM Relative
Valuation
Target Price as of
11.11.18 $116.06 $125.23 $86.29
DCF/EP
The DCF/EP model is based on our research and beliefs about
the Valero’s riskiness and growth; therefore, we believe it is the
most informed model for calculating the intrinsic value of
Valero’s stock. Valero’s steady, strong growth through
efficiency improvements and expansion seem to justify a higher
stock value of $116.06.
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The DCF model determines the value of operating assets using
the sum of the present values of free cash flows (net operating
profit less adjusted taxes, i.e., NOPLAT, less capital
expenditures). Alternatively, the EP model uses present value of
economic profit (the difference between ROIC and WACC)
added to beginning invested capital to calculate the value of
operating assets. Both approaches use the WACC for
discounting. For the DCF and EP models, we estimated
continuing value (CV) growth of NOPLAT to be 3%, the effects
of which we tested in our sensitivity analysis. As CV growth
rises, intrinsic stock price falls, because our model predicts a
lower ROIC than WACC in the CV year. Given our short
investment horizon, we do not believe this projected future
destruction of value is cause for concern. DDM
The DDM may be useful for understanding the value of VLO
stock, however, it does not represent the whole story of Valero
as a company. The DDM calculates intrinsic stock value using
the present value of future dividend payments. This present
value is found by discounting back estimated future dividends
and a perpetual value of future cash flows past a CV year. We
decided this model was less informative than the DCF/EP
model, as the DDM is heavily based on one assumption: a
constant dividend per share of $3.60. Relative Valuation
The relative P/E valuation produces a stock price similar to
VLO’s current stock price, however, it is likely not a reflection
of Valero’s fundamental value. The relative P/E calculation uses
an average of industry peers’ estimated P/E ratio multiplied by
our forecasted earnings per share to estimate an implied value.
While this approach may be useful for comparison purposes or
quick value estimations, its oversimplification of reality--that
Valero’s P/E should be identical to the average of its peers-- is
not particularly helpful for our analysis. Sensitivity Analysis WACC, Equity Risk Premium
As a key assumption in the DCF/EP model, the WACC has a
large impact on our estimation of intrinsic stock value. The
equity risk premium influences the WACC, and we can see that
changes in the equity risk premium make incremental
differences in stock price.
Beta, Risk Free Rate
Small changes in the risk free rate make a larger impact on stock
price than small changes in Beta; however, neither of these
factors alone change the model too much. Both assumptions
make up just a portion of the WACC, as they flow into equity
risk premium.
Normal Cash Percentage of Sales, CV Growth of NOPLAT
Normal cash percentage of sales and CV growth of NOPLAT
affect the value of operations and make marginal differences in
the dollar-value of equity. Normal cash percentage of sales is
based on the convention of the industry, which is low due to
energy companies’ high sales figures that do not necessarily
translate into proportionally high income. Increases in normal
cash percentage of sales raise invested capital. CV growth of
NOPLAT causes stock price to fall when it rises, because CV
ROIC is less than WACC.
2018 Utilization, 2022 Crack Spread Utilization and crack spread assumptions flow across the model
from the revenue decomposition to the DCF/EP, and make
significant differences in the estimated stock price. We grow
utilization from 83% to 93% from 2018 to 2022, based off Q1-
Q3 2018 figures and consistent past utilization improvements.
Crack spreads largely determine Valero’s income, and
consequently have a large impact on the model. Both of these
are debatably strong assumptions, so this data table may be
useful for evaluation of our model.
Current Dividend Yield, 2022 Refining Price per BOE Current dividend yield and refining price per BOE both have
little impact on the DCF/EP model. Dividend yield impacts cash
and the partial-year adjustment, so as it increases, price
decreases slightly. CV year refining price per barrel of oil has
little effect on price because Valero’s income is mainly driven
by the crack spread they face, not pure revenues.
11 | P a g e
Important Disclaimer
This report was created by students enrolled in the Security
Analysis (6F:112) class at the University of Iowa. The report
was originally created to offer an internal investment
recommendation for the University of Iowa Krause Fund and its
advisory board. The report also provides potential employers and
other interested parties an example of the students’ skills,
knowledge and abilities. Members of the Krause Fund are not
registered investment advisors, brokers or officially licensed
financial professionals. The investment advice contained in this
report does not represent an offer or solicitation to buy or sell
any of the securities mentioned. Unless otherwise noted, facts
and figures included in this report are from publicly available
sources. This report is not a complete compilation of data, and
its accuracy is not guaranteed. From time to time, the University
of Iowa, its faculty, staff, students, or the Krause Fund may hold
a financial interest in the companies mentioned in this report.
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&s=mcrfpus1&f=m.
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436a-bd45-88fed6ae9387.
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12 | P a g e
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c.
Valero Energy CorporationKey Assumptions of Valuation Model
Ticker Symbol VLOCurrent Share Price $87.58Current Model Date 11/13/2018FY End (month/day) Dec. 31
Pre-Tax Cost of Debt 4.41%Beta 0.91Risk-Free Rate 3.186%Equity Risk Premium 5.32%CV Growth of NOPLAT 3.00%CV Growth of EPS 3%CV ROIC 6.68%Current Dividend Yield 3.20%Marginal Tax Rate 21%Normal Cash % 0.70%Debt Rating BBBWACC 7.09%Cost of Equity 0.0802722022 Crack Spread 12.46$ 2022 Refining Price per BOE 60.06$
Intrinsic Stock Value 116.06$
Refining Price per BOE 60.81$ Utilization 83%
Valero Energy CorporationRevenue Decomposition
Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E 2022ERefining Revenues
Gasonline and Blendstocks 38,983.00$ 33,450.00$ 40,362.00$ $ 57,662.08 $ 60,866.73 $ 62,129.38 $ 63,205.78 $ 64,098.74 Distillates and Other 45,538.00 38,500.00 50,289.00 67,896.97 72,419.12 73,399.34 75,366.39 76,828.62 Total 84,521.00$ 71,950.00$ 90,651.00$ $ 125,559.05 $ 133,285.85 $ 135,528.72 $ 138,572.17 $ 140,927.37 Ethanol Revenues
Ethanol 2,628.00$ 3,105.00$ 2,764.00$ $ 2,963.39 $ 3,038.13 $ 3,111.62 $ 3,187.32 $ 3,264.09 Other 655.00 586.00 560.00 534.07 499.17 473.22 447.40 421.77
Total $ 3,283.00 $ 3,691.00 $ 3,324.00 $ 3,497.46 $ 3,537.31 $ 3,584.83 $ 3,634.72 $ 3,685.86 Total Revenue $ 87,804.00 $ 75,641.00 $ 93,980.00 $ 129,056.51 $ 136,823.16 $ 139,113.56 $ 142,206.89 $ 144,613.22
Refining Throughput Volumes in Millions of Barrels 870.53 889.75 939.15 948.23 976.68 1,005.98 1,036.16 1,067.25 Ethanol Production Volumes in Millions of Gallons 1,396.86 1,406.17 1,449.78 1,482.69 1,520.08 1,556.85 1,594.73 1,633.14 Refining Revenue Per Barrel 44.78$ 37.59$ 42.98$ 60.81$ 62.32$ 61.76$ 61.00$ 60.06$ Ethanol Revenue Per Gallon 1.88$ 2.21$ 1.91$ 2.00$ 2.00$ 2.00$ 2.00$ 2.00$ Crack Spread Estimation 16.02$ 10.90$ 11.65$ 12.18$ 12.25$ 12.32$ 12.39$ 12.46$
Valero Energy CorporationIncome Statement
Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E 2022E (CV)
Operating Revenues (a) 87,804.00$ 75,659.00$ 93,980.00$ $ 129,056.51 $ 136,823.16 $ 139,113.56 $ 142,206.89 $ 144,613.22 Cost & Expenses:
Cost of materials and other 73,861.00 65,962.00 83,037.00 117,328.68 124,685.98 126,545.10 129,192.60 131,136.37 Operating expenses 4,243.00 4,207.00 4,462.00 4,462.00 4,462.00 4,462.00 4,462.00 4,462.00 Depreciation & amortization expense 1,842.00 1,894.00 1,986.00 2,061.62 2,102.96 2,152.98 2,202.73 2,253.45 General & administrative expenses 710.00 715.00 835.00 835.00 835.00 835.00 835.00 835.00
Total Costs & Expenses 81,446.00$ 72,087.00$ 90,381.00$ 124,687.30$ 132,085.94$ 133,995.08$ 136,692.34$ 138,686.82$ Operating income (loss) 6,358.00 3,572.00 3,599.00 4,369.21 4,737.22 5,118.47 5,514.55 5,926.40 Other income (expense), net 46.00 56.00 76.00 57.30 57.30 57.30 57.30 57.30 Interest & debt expense, net of capitalized interest (433.00) (446.00) (468.00) (391.52) (364.01) (404.42) (440.81) (448.68) Income before income tax expense (benefit) 5,971.00 3,182.00 3,207.00 4,034.99 4,430.52 4,771.35 5,131.05 5,535.02 Income tax expense (benefit) 1,870.00 765.00 (949.00) 847.35 930.41 1,001.98 1,077.52 1,162.35
Net income (loss) 4,101.00$ 2,417.00$ 4,156.00$ 3,187.64$ 3,500.11$ 3,769.37$ 4,053.53$ 4,372.66$ Less: net income (loss) attributable to noncontrolling interests (111.00) (128.00) (91.00) (91.00) (91.00) (91.00) (91.00) (91.00) Net income (loss) attributable to Valero Energy Corporation stockholders 3,990.00$ 2,289.00$ 4,065.00$ 3,096.64$ 3,409.11$ 3,678.37$ 3,962.53$ 4,281.66$
Basic EPS 8.00$ 4.94$ 9.17$ 6.99$ 7.69$ 8.30$ 8.94$ 9.66$ Basic weighted average shares outstanding 498.75 463.36 443.29 443.29 443.26 443.23 443.20 443.17Dividends per share 1.70$ 2.40$ 2.80$ 3.60$ 3.60$ 3.60$ 3.60$ 3.60$
Valero Energy CorporationBalance SheetIn Millions $Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E 2022E
ASSETS
Current Assets: Cash & temporary cash investments 4,114.00$ 4,816.00$ 5,850.00$ $ 5,356.72 $ 7,277.57 $ 9,560.75 $ 11,449.99 $ 13,711.67 Receivables, net 4,464.00 5,901.00 6,922.00 7,448.78 7,897.05 8,029.24 8,207.78 8,346.67 Inventories 5,898.00 5,709.00 6,384.00 7,300.21 7,739.54 7,869.09 8,044.07 8,180.19 Income taxes receivable 218.00 58.00 - - - - - - Deferred income taxes 74.00 - - - - - - - Prepaid expenses & other current assets 204.00 316.00 156.00 296.41 314.24 319.50 326.61 332.14
Total Current Assets 14,972.00$ 16,800.00$ 19,312.00$ 20,402.11$ 23,228.40$ 25,778.59$ 28,028.45$ 30,570.67$ Property, plant & equipment, at cost 36,907.00 37,733.00 40,010.00 42,622.55 45,392.33 48,208.47 51,087.23 54,014.71 Accumulated depreciation 10,204.00 11,261.00 12,530.00 14,591.62 16,694.58 18,847.56 21,050.29 23,303.74 Property, plant & equipment, net 26,703.00 26,472.00 27,480.00 28,030.93 28,697.75 29,360.91 30,036.94 30,710.96 Deferred charges & other assets, net 2,668.00 2,901.00 3,366.00 2,688.04 2,849.81 2,897.52 2,961.95 3,012.07 Total Assets 44,343.00$ 46,173.00$ 50,158.00$ 51,121.09$ 54,775.97$ 58,037.02$ 61,027.34$ 64,293.70$
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities: Current portion of debt & capital lease obligations 127.00$ 115.00$ 122.00$ 161.00$ 811.00$ 1,319.00$ 1,319.00$ 1,319.00$ Accounts payable 4,907.00 6,357.00 8,348.00 9,028.59 9,571.94 9,732.17 9,948.57 10,116.92 Accrued expenses 554.00 694.00 712.00 756.32 801.83 815.25 833.38 847.48 Taxes other than income taxes payables 1,069.00 1,084.00 1,321.00 1,307.79 1,386.49 1,409.70 1,441.05 1,465.43 Income taxes payable 337.00 78.00 568.00 68.49 75.21 80.99 87.10 93.95 Deferred income taxes 366.00 - - - - - - -
Total Current Liabilities 7,360.00$ 8,328.00$ 11,071.00$ 11,322.19$ 12,646.46$ 13,357.11$ 13,629.10$ 13,842.79$ Debt & capital lease obligations, less current portion 7,250.00 7,886.00 8,750.00 8,087.47 8,353.30 8,669.81 8,848.30 9,049.28 Deferred income taxes 6,768.00 7,361.00 4,708.00 4,836.36 4,968.23 5,103.69 5,242.84 5,385.79 Total other long-term liabilities 1,611.00 1,744.00 2,729.00 2,508.53 2,659.49 2,704.01 2,764.14 2,810.91 Total Liabilities 22,989.00$ 25,319.00$ 27,258.00$ 26,754.56$ 28,627.49$ 29,834.63$ 30,484.38$ 31,088.76$ Stockholders' Equity: Common stock 7,071.00 7,095.00 7,046.00 7,046.00 7,046.00 7,046.00 7,046.00 7,046.00 Treasury stock, at cost (10,799.00) (12,027.00) (13,315.00) (13,349.25) (13,380.68) (13,409.51) (13,435.96) (13,460.23) Retained earnings (accumulated deficit) 25,188.00 26,366.00 29,200.00 30,700.78 32,514.16 34,596.90 36,963.92 39,650.16 Accumulated other comprehensive income (loss) (933.00) (1,410.00) (940.00) (940.00) (940.00) (940.00) (940.00) (940.00) Total Valero Energy Corporation stockholders' equity 20,527.00 20,024.00 21,991.00 23,457.53 25,239.48 27,293.39 29,633.96 32,295.93 Noncontrolling interests 827.00 830.00 909.00 909.00 909.00 909.00 909.00 909.00 Total Stockholders' Equity 21,354.00$ 20,854.00$ 22,900.00$ 24,366.53$ 26,148.48$ 28,202.39$ 30,542.96$ 33,204.93$ Total Liabilities and Stockholders' Equity 44,343.00$ 46,173.00$ 50,158.00$ 51,121.09$ 54,775.97$ 58,037.02$ 61,027.34$ 64,293.70$
Valero Energy CorporationCash Flow StatementIn Millions $Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E 2022ECASH FLOWS FROM OPERATING ACTIVITIES
Net Income (loss) 4,101.00$ 2,417.00$ 4,156.00$ $ 3,096.64 $ 3,409.11 $ 3,678.37 $ 3,962.53 $ 4,281.66 Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation & amortization expense 1,842.00 1,894.00 1,986.00 2,061.62 2,102.96 2,152.98 2,202.73 2,253.45 Stock-based compensation expense - - - - - - - - Deferred income tax expense (benefit) 165.00 230.00 (2,543.00) 128.36 131.86 135.46 139.15 142.95
Changes in Assets and Liabilities:Restricted cash - - - - - - - - Receivables, net 1,294.00 (1,531.00) (870.00) (526.78) (448.27) (132.20) (178.54) (138.89) Inventories (222.00) 771.00 (516.00) (916.21) (439.33) (129.56) (174.98) (136.12) Income taxes receivable (104.00) 156.00 - - - - - - Prepaid expenses & other current assets (45.00) (109.00) 151.00 (140.41) (17.84) (5.26) (7.10) (5.53) Accounts payable (1,787.00) 1,556.00 1,842.00 680.59 543.34 160.23 216.40 168.34 Accrued expenses (40.00) 117.00 21.00 44.32 45.52 13.42 18.13 14.10 Taxes other than income taxes (74.00) 82.00 172.00 (13.21) 78.70 23.21 31.35 24.38 Income taxes payable (328.00) (66.00) 489.00 (499.51) 6.71 5.79 6.11 6.86 Deferred charges & credits & other operating activities, net 19.00 (6.00) 594.00 677.96 (161.77) (47.71) (64.43) (50.12)
Net Cash Flows from Operating Activities 5,611.00$ 4,820.00$ 5,482.00$ 4,593.38$ 5,251.00$ 5,854.74$ 6,151.35$ 6,561.10$
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (1,618.00)$ (1,278.00)$ (1,353.00)$ (2,612.55)$ (2,769.78)$ (2,816.14)$ (2,878.76)$ (2,927.47)$ Net Cash Flows from Investing Activities (2,487.00)$ (2,006.00)$ (2,382.00)$ (2,612.55)$ (2,769.78)$ (2,816.14)$ (2,878.76)$ (2,927.47)$
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under long-term debt 39.00 650.00 508.00 - - Current portion of long-term debt (662.53) 265.83 316.51 178.49 200.98 Other liabilities (220.47) 150.96 44.52 60.13 46.77 Purchase of common stock for treasury (2,838.00) (1,336.00) (1,372.00) (34.25) (31.43) (28.83) (26.45) (24.27) Dividends Paid (848.00) (1,111.00) (1,242.00) (1,595.86) (1,595.73) (1,595.62) (1,595.52) (1,595.42) Other financing activities, net 25.00 (184.00) (26.00) - - - - -
Net Cash Flows from Financing Activities (2,545.00)$ (2,012.00)$ (2,272.00)$ (2,474.11)$ (560.37)$ (755.42)$ (1,383.35)$ (1,371.94)$
Net increase (decrease) in cash & temporary cash investments 425.00 702.00 1,034.00 (493.28) 1,920.86 2,283.17 1,889.24 2,261.69 Cash & temporary cash investments at beginning of year 3,689.00 4,114.00 4,816.00 5,850.00 5,356.72 7,277.57 9,560.75 11,449.99 Cash & temporary cash investments at end of year 4,114.00$ 4,816.00$ 5,850.00$ 5,356.72$ 7,277.57$ 9,560.75$ 11,449.99$ 13,711.67$
Valero Energy CorporationCommon Size Income Statement
Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E 2022E
Operating revenues (a) 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%Cost of sales:
Cost of materials and other 84.12% 87.18% 88.36% 90.91% 91.13% 90.97% 90.85% 90.68% Operating expenses 4.83% 5.56% 4.75% 3.46% 3.26% 3.21% 3.14% 3.09% Depreciation & amortization expense 2.10% 2.50% 2.11% 1.60% 1.54% 1.55% 1.55% 1.56% Total cost of sales 91.95% 94.26% 95.22% 95.97% 95.93% 95.72% 95.53% 95.32%General & administrative expenses 0.81% 0.95% 0.89% 0.65% 0.61% 0.60% 0.59% 0.58%Total costs & expenses 92.76% 95.28% 96.17% 96.61% 96.54% 96.32% 96.12% 95.90%Operating income (loss) 7.24% 4.72% 3.83% 3.39% 3.46% 3.68% 3.88% 4.10%Other income (expense), net 0.05% 0.07% 0.08% 0.04% 0.04% 0.04% 0.04% 0.04%Interest & debt expense, net of capitalized interest -0.49% -0.59% -0.50% -0.30% -0.27% -0.29% -0.31% -0.31%Income before income tax expense (benefit) 6.80% 4.21% 3.41% 3.13% 3.24% 3.43% 3.61% 3.83%Income tax expense (benefit) 2.13% 1.01% -1.01% 0.66% 0.68% 0.72% 0.76% 0.80%Net income (loss) 4.67% 3.19% 4.42% 2.47% 2.56% 2.71% 2.85% 3.02% Less: net income (loss) attributable to noncontrolling interests -0.13% -0.17% -0.10% -0.07% -0.07% -0.07% -0.06% -0.06%Net income (loss) attributable to Valero Energy Corporation stockholders 4.54% 3.03% 4.33% 2.40% 2.49% 2.64% 2.79% 2.96%
Valero Energy CorporationCommon Size Balance Sheet
Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E 2022E
Assets
Current assets: Cash & temporary cash investments 4.69% 6.37% 6.22% 4.15% 5.32% 6.87% 8.05% 9.48% Receivables, net 5.08% 7.80% 7.37% 5.77% 5.77% 5.77% 5.77% 5.77% Inventories 6.72% 7.55% 6.79% 5.66% 5.66% 5.66% 5.66% 5.66% Income taxes receivable 0.25% 0.08% - - - - - - Deferred income taxes 0.08% - - - - - - - Prepaid expenses & other current assets 0.23% 0.42% 0.17% 0.23% 0.23% 0.23% 0.23% 0.23% Total current assets 17.05% 22.20% 20.55% 15.81% 16.98% 18.53% 19.71% 21.14%Property, plant & equipment, at cost 42.03% 49.87% 42.57% 33.03% 33.18% 34.65% 35.92% 37.35%Accumulated depreciation 11.62% 14.88% 13.33% 11.31% 12.20% 13.55% 14.80% 16.11% Property, plant & equipment, net 30.41% 34.99% 29.24% 21.72% 20.97% 21.11% 21.12% 21.24%Deferred charges & other assets, net 3.04% 3.83% 3.58% 2.08% 2.08% 2.08% 2.08% 2.08% Total assets 50.50% 61.03% 53.37% 39.61% 40.03% 41.72% 42.91% 44.46%
Liabilities and Equity
Current Liabilities:
Current portion of debt & capital lease obligations 0.14% 0.15% 0.13% 0.12% 0.59% 0.95% 0.93% 0.91% Accounts payable 5.59% 8.40% 8.88% 7.00% 7.00% 7.00% 7.00% 7.00% Accrued expenses 0.63% 0.92% 0.76% 0.59% 0.59% 0.59% 0.59% 0.59% Taxes other than income taxes 1.22% 1.43% 1.41% 1.01% 1.01% 1.01% 1.01% 1.01% Income taxes payable 0.38% 0.10% 0.60% 0.05% 0.05% 0.06% 0.06% 0.06% Deferred income taxes 0.42% - - - - - - - Total current liabilities 8.38% 11.01% 11.78% 8.77% 9.24% 9.60% 9.58% 9.57%Debt & capital lease obligations, less current portion 8.26% 10.42% 9.31% 6.27% 6.11% 6.23% 6.22% 6.26%Deferred income taxes 7.71% 9.73% 5.01% 3.75% 3.63% 3.67% 3.69% 3.72%Total other long-term liabilities 1.83% 2.31% 2.90% 1.94% 1.94% 1.94% 1.94% 1.94% Total liabilities 26.18% 33.46% 29.00% 20.73% 20.92% 21.45% 21.44% 21.50%Equity:
Valero Energy Corporation stockholders' equity:
Common stock 8.05% 9.38% 7.50% 5.46% 5.15% 5.06% 4.95% 4.87% Additional paid-in capital -12.30% -15.90% -14.17% -10.34% -9.78% -9.64% -9.45% -9.31% Treasury stock, at cost -12.30% -15.90% -14.17% -10.34% -9.78% -9.64% -9.45% -9.31% Retained earnings (accumulated deficit) 28.69% 34.85% 31.07% 23.79% 23.76% 24.87% 25.99% 27.42% Accumulated other comprehensive income (loss) -1.06% -1.86% -1.00% -0.73% -0.69% -0.68% -0.66% -0.65% Total Valero Energy Corporation stockholders' equity 23.38% 26.47% 23.40% 18.18% 18.45% 19.62% 20.84% 22.33% Noncontrolling interests 0.94% 1.10% 0.97% 0.70% 0.66% 0.65% 0.64% 0.63% Total equity 24.32% 27.56% 24.37% 18.88% 19.11% 20.27% 21.48% 22.96% Total liabilities and equity 50.50% 61.03% 53.37% 39.61% 40.03% 41.72% 42.91% 44.46%
Valero Energy CorporationValue Driver EstimationIn MillionsFiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E 2022E
NOPLAT ComputationEBITA:Net Sales $ 87,804.00 $ 75,659.00 $ 93,980.00 $ 129,056.51 $ 136,823.16 $ 139,113.56 $ 142,206.89 $ 144,613.22 - Cost of Goods Sold (73,861.00) (65,962.00) (83,037.00) (117,328.68) (124,685.98) (126,545.10) (129,192.60) (131,136.37) - Operating Expenses (4,243.00) (4,207.00) (4,462.00) (4,462.00) (4,462.00) (4,462.00) (4,462.00) (4,462.00) - Depletion, depreciation and amortization (1,842.00) (1,894.00) (1,986.00) (2,061.62) (2,102.96) (2,152.98) (2,202.73) (2,253.45) - General and administrative expenses 710.00 715.00 835.00 (835.00) (835.00) (835.00) (835.00) (835.00) + Implied Interest on Operating Leases 46.37 45.05 56.38 63.30 64.81 66.31 67.83 69.35 EBITA 8,614.37$ 4,356.05$ 5,447.38$ 4,432.51$ 4,802.03$ 5,184.78$ 5,582.39$ 5,995.76$
LESS: Adjusted TaxesProvision for Income Taxes 1,870.00 765.00 (949.00) 847.35 930.41 1,001.98 1,077.52 1,162.35 + Tax shield on interest & debt expense, net of capitalized interest 90.93 93.66 98.28 82.22 76.44 84.93 92.57 94.22 + Tax Shield on Implied Lease Interest 9.74 9.46 11.84 13.29 13.61 13.92 14.24 14.56 - Tax on Other Income (9.66) (11.76) (15.96) (12.03) (12.03) (12.03) (12.03) (12.03) Adjusted Taxes 1,970.67$ 879.88$ (838.88)$ 930.83$ 1,008.43$ 1,088.80$ 1,172.30$ 1,259.11$
PLUS: Change in Deferred Tax LiabilitiesCurrent year DTL 366.00 - - - - - - - - Current year DTA 74.00 - - - - - - - Net DTL for current year 292.00 - - - - - - -
Previous year DTL 376.00 366.00 - - - - - - - Previous year DTA 162.00 74.00 - - - - - - Net DTL for previous year 214.00 292.00 - - - - - -
Net Change in DtL (Current-Previous year) 78.00 (292.00) - - - - - -
NOPLAT: EBIT - Adjusted Taxes + Change in DT 6,721.71$ 3,184.17$ 6,286.26$ 3,501.68$ 3,793.60$ 4,095.97$ 4,410.09$ 4,736.65$
Invested Capital Computation
Operating Current Assets:Normal Cash 614.63 529.61 657.86 903.40 957.76 973.79 995.45 1,012.29 Accounts Recievable 4,464.00 5,901.00 6,922.00 7,448.78 7,897.05 8,029.24 8,207.78 8,346.67 Inventories 5,898.00 5,709.00 6,384.00 7,300.21 7,739.54 7,869.09 8,044.07 8,180.19 Prepaid Expenses 204.00 316.00 156.00 296.41 314.24 319.50 326.61 332.14 Income tax recievable 218.00 58.00 - - - - - - Operating Current Assets: $11,398.63 $12,513.61 $14,119.86 $15,948.79 $16,908.59 $17,191.64 $17,573.91 $17,871.29
Operating Current Liabilities:Accounts Payable 4,907.00 6,357.00 8,348.00 9,028.59 9,571.94 9,732.17 9,948.57 10,116.92 Income taxes payable 337.00 78.00 568.00 68.49 75.21 80.99 87.10 93.95 Operating Current Liabilities 5,244.00$ 6,435.00$ 8,916.00$ 9,097.09$ 9,647.14$ 9,813.16$ 10,035.67$ 10,210.87$
Net Working Capital $6,154.63 $6,078.61 $5,203.86 $6,851.70 $7,261.45 $7,378.48 $7,538.24 $7,660.41
PLUS: Net PPE 26,703.00 26,472.00 27,480.00 28,030.93 28,697.75 29,360.91 30,036.94 30,710.96
PLUS: PV of operating leases 1,050.85 1,020.78 1,277.48 1,434.45 1,468.58 1,502.51 1,537.11 1,571.60
PLUS: Other L-T operating assetsOther 2,668.00 2,901.00 3,366.00 2,688.04 2,849.81 2,897.52 2,961.95 3,012.07
Total Other L-T operating assets 30,421.85 30,393.78 32,123.48 32,153.43 33,016.14 33,760.94 34,535.99 35,294.63
LESS: Other L-T operating liabilities 1,611.00 1,744.00 2,729.00 2,508.53 2,659.49 2,704.01 2,764.14 2,810.91
Invested Capital: $62,719.33 $62,221.18 $63,355.82 $65,961.98 $67,784.42 $69,298.83 $70,884.14 $72,426.69
ROIC=NOPLAT/Beginning ICNOPLAT 6,721.71$ 3,184.17$ 6,286.26$ 3,501.68$ 3,793.60$ 4,095.97$ 4,410.09$ 4,736.65$ Beginning IC 62,505.13$ 62,719.33$ 62,221.18$ 63,355.82$ 65,961.98$ 67,784.42$ 69,298.83$ 70,884.14$
Return on Invested Capital 10.75% 5.08% 10.10% 5.53% 5.75% 6.04% 6.36% 6.68%FCF=NOPLAT-Change in IC
NOPLAT 6,721.71$ 3,184.17$ 6,286.26$ 3,501.68$ 3,793.60$ 4,095.97$ 4,410.09$ 4,736.65$ Change in IC 214.20$ (498.15)$ 1,134.64$ 2,606.16$ 1,822.44$ 1,514.41$ 1,585.31$ 1,542.55$
Free Cash Flows 6,507.51$ 3,682.32$ 5,151.62$ 895.52$ 1,971.16$ 2,581.57$ 2,824.77$ 3,194.09$ EP=Beginning IC*(ROIC-WACC)
Beginning IC $62,505.13 $62,719.33 $62,221.18 $63,355.82 $65,961.98 $67,784.42 $69,298.83 $70,884.14ROIC 10.75% 5.08% 10.10% 5.53% 5.75% 6.04% 6.36% 6.68%WACC 10.00% 10.00% 10.00% 7.09% 7.09% 7.09% 7.09% 7.09%
Economic Profit 471.19$ (3,087.77)$ 64.14$ (987.78)$ (880.54)$ (707.30)$ (500.51)$ (286.28)$
Valero Energy CorporationWeighted Average Cost of Capital (WACC) Estimation
Risk Free Rate 3.19%Risk Premium 5.32%Beta 0.91Cost of Equity 8.03%
Cost of DebtDebt Rating BBBPre-tax Cost of Debt 4.41%Tax Rate 21%After-Tax Cost of Debt 3.49%
MV of EquityShares Outstanding 443.29 Share Price $87.58MV of Equity 38,823.63
MV of DebtCurrent Portion of Long-Term Debt 122.00 Long-Term Debt 8,750.00 Operating Leases 1,277.48 MV of Debt 10,149.48
Weights% Equity 79%% Debt 21%
WACC 7.09%
Valero Energy CorporationDiscounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models
Key Inputs: CV Growth 3.00% CV ROIC 6.36% WACC 7.09% Cost of Equity 8.03%
Fiscal Years Ending Dec. 31 2018E 2019E 2020E 2021E 2022E (CV)
DCF ModelNOPLAT 3502 3794 4096 4410 4737CapEx 2606 1822 1514 1585 1543Unlevered Free Cash Flow 896 1971 2582 2825 3194ROIC 5.53% 5.75% 6.04% 6.36% 6.68%Continuing Value 63878
Periods to Discount 1 2 3 4 4
Present Value of FCF 836 1719 2102 2148Present Value of CV 48576
Value of Operating Assets (Millions) 55,381$ Excess Cash 5,192$ Debt 8,872$ PV of Operating Leases 1,277$ PV of Stock Options 24$ Non controlling interests (940)$ Value of Equity 49,460.20$ Shares Outstanding 444.00 Intrinsic Value per Share 111.40$ Target Price as of 11/11/2018 116.06$
EP ModelBeginning Invested Capital 63356 65962 67784 69299 70884ROIC 5.53% 5.75% 6.04% 6.36% 6.68%Economic Profit -988 -881 -707 -501 -286Economic Profit (CV) -7006
Periods to Discount 1 2 3 4 4Present Value of Economic Profit -922 -768 -576 -381 -5328Present Value -7975Beginning Invested Capital 63356Value of Operating Assets 55381Excess Cash 5192Debt 8872PV of Operating Leases 1277PV of Stock Options 24Non controlling interests -940Value of Equity 49,460.20$ Shares Outstanding 444Intrinsic Value per Share 111.40$ Target Price as of 11/11/2018 116.06$
Valero Energy CorporationDividend Discount Model (DDM) or Fundamental P/E Valuation Model
Fiscal Years Ending 2018E 2019E 2020E 2021E 2022E (CV)
EPS 6.99$ 7.69$ 8.30$ 8.94$ 9.66$
Key Assumptions CV growth 3.00% CV ROE 12.89% Cost of Equity 8.03%
Future Cash Flows P/E Multiple (CV Year) 15.26$ EPS (CV Year) 9.66$ Future Stock Price 147.47$ Dividends Per Share 3.60$ 3.60$ 3.60$ 3.60$ Number of Periods 1 2 3 4 4 Discounted Cash Flows 3.332 3.085 2.856 2.643 108.286
Intrinsic Value 120.20$ Target Price as of 11/11/18 125.23$
For Discounting:Number of Periods 1 2 3 4 5
Model Date 11/13/2018Next FYE 12/31/2018Last FYE 12/31/2017Days in FY 365 Days to FYE 317 Elapsed Fraction 0.868
Valero Energy CorporationRelative Valuation Models
EPS EPSTicker Company Price 2018E 2019E P/E 18 P/E 19 Enterprise Value EBITA EV/EBITADK Delek US Holdings, Inc. $38.95 $4.80 $6.75 8.11 5.77 4,220,000,000 631,736,527 6.68PSX Phillips 66 $99.74 $8.89 $9.84 11.22 10.14 58,240,000,000 4,165,951,359 13.98XOM Exxon Mobil Corporation $80.87 $4.78 $5.82 16.92 13.90 382,130,000,000 36,849,566,056 10.37INT World Fuel Services Corporation $29.42 $2.06 $2.30 14.28 12.79 2,460,000,000 291,469,194 8.44HFC HFC Inc. $64.70 $5.76 $7.65 11.23 8.46 13,220,000,000 2,101,748,808 6.29
Average 12.35 10.21 9.15
VLO Valero Energy Corporation $87.58 $ 6.99 $ 7.69 12.5 11.4 44,811,128,000 5,447,375,152 8.23
Implied Relative Value: P/E (EPS18) $ 86.29 P/E (EPS19) 78.53$ Enterprise Value 44,811,128,000.00$ Shares Outstanding 443,259,093.48$ Share Price 101.09$
Valero Energy CorporationKey Management Ratios
Fiscal Years Ending Definition 2015 2016 2017 2018E 2019E 2020E 2021E 2022E
Liquidity RatiosCurrent Ratio Current Assets/Current Liabilities 2.03 2.02 1.74 1.80 1.84 1.93 2.06 2.21 Operating CF Ratio Cash Flow from Operations/Current Liabilities 0.76 0.58 0.50 0.41 0.42 0.44 0.45 0.47 Quick Ratio Liquid Assets/Current Liabilities 1.17 1.29 1.15 1.13 1.20 1.32 1.44 1.59
Activity or Asset-Management RatiosAsset Turnover Sales/Average Total Assets 1.95 1.67 1.95 2.55 2.58 2.47 2.39 2.31Receivables Turnover Credit Sales/Average Accounts Receivable 16.98 14.60 14.66 17.96 17.83 17.47 17.52 17.47Inventory Turnover Sales/Average Inventory 14.03 13.04 15.54 18.86 18.19 17.83 17.87 17.83
Financial Leverage RatiosDebt-to-Equity Total Liabilities/Stockholders' Equity 1.08 1.21 1.19 1.10 1.09 1.06 1.00 0.94 Equity Ratio Stockholders' Equity/Total Assets 0.48 0.45 0.46 0.48 0.48 0.49 0.50 0.52
Profitability RatiosReturn on Assets Net Income/Average Total Assets 8.88% 5.06% 8.44% 6.12% 6.44% 6.52% 6.66% 6.83%Return on Equity Net Income/Average Stockholders' Equity 18.73% 10.85% 18.58% 13.10% 13.50% 13.54% 13.49% 13.43%Profit Margin Net Income/Net Sales 4.54% 3.03% 4.33% 2.40% 2.49% 2.64% 2.79% 2.96%Gross Margin (Revenue-COGS)/Revenue 15.88% 12.82% 11.64% 9.09% 8.87% 9.03% 9.15% 9.32%
Payout Policy RatiosPayout Ratio Dividends per Share/Earnings per Share 21.25% 48.58% 30.53% 51.54% 46.81% 43.38% 40.27% 37.26%Total Payout (Dividends+Repurchases)/Net Income 89.881% 101.241% 62.897% 52.64% 47.73% 44.16% 40.93% 37.83%
Present Value of Operating Lease Obligations (2017) Present Value of Operating Lease Obligations (2016) Present Value of Operating Lease Obligations (2015)
Operating Operating OperatingFiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending 129.612845424997 Leases2017 479 2016 430 2015 3142018 321 2017 283 2016 2292019 221 2018 200 2017 1582020 162 2019 143 2018 1312021 106 2020 100 2019 75Thereafter 362 Thereafter 311 Thereafter 275Total Minimum Payments 1651 Total Minimum Payments 1467 Total Minimum Payments 1182Less: Interest 217 Less: Interest 190 Less: Interest 161PV of Minimum Payments 1434 PV of Minimum Payments 1277 PV of Minimum Payments 1021
Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases
Pre-Tax Cost of Debt 4.41% Pre-Tax Cost of Debt 4.41% Pre-Tax Cost of Debt 4.41%Number Years Implied by Year 6 Payment 3.4 Number Years Implied by Year 6 Payment 3.1 Number Years Implied by Year 6 Payment 3.7
Lease PV Lease Lease PV Lease Lease PV LeaseYear Commitment Payment Year Commitment Payment Year Commitment Payment1 479 458.8 1 430 411.8 1 314 300.72 321 294.4 2 283 259.6 2 229 210.13 221 194.1 3 200 175.7 3 158 138.84 162 136.3 4 143 120.3 4 131 110.25 106 85.4 5 100 80.6 5 75 60.46 & beyond 106 265.4 6 & beyond 100 229.5 6 & beyond 75 200.5PV of Minimum Payments 1434.5 PV of Minimum Payments 1277.5 PV of Minimum Payments 1020.8
Present Value of Operating Lease Obligations (2014) Present Value of Operating Lease Obligations (2013) Present Value of Operating Lease Obligations (2012)
Operating Operating OperatingFiscal Years Ending 129.612845424997 Leases Fiscal Years Ending 78.0797690487375 Leases Fiscal Years Ending 36.2098774239726 Leases2014 305 2013 337 2012 2912015 230 2014 250 2013 1982016 162 2015 179 2014 1312017 111 2016 133 2015 1062018 95 2017 86 2016 86Thereafter 321 Thereafter 350 Thereafter 294Total Minimum Payments 1224 Total Minimum Payments 1335 Total Minimum Payments 1106Less: Interest 173 Less: Interest 191 Less: Interest 157PV of Minimum Payments 1051 PV of Minimum Payments 1144 PV of Minimum Payments 949
Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases
Pre-Tax Cost of Debt 4.41% Pre-Tax Cost of Debt 4.41% Pre-Tax Cost of Debt 4.41%Number Years Implied by Year 6 Payment 3.4 Number Years Implied by Year 6 Payment 4.1 Number Years Implied by Year 6 Payment 3.4
Lease PV Lease Lease PV Lease Lease PV LeaseYear Commitment Payment Year Commitment Payment Year Commitment Payment1 305 292.1 1 337 322.8 1 291 278.72 230 211.0 2 250 229.3 2 198 181.63 162 142.3 3 179 157.2 3 131 115.14 111 93.4 4 133 111.9 4 106 89.25 95 76.6 5 86 69.3 5 86 69.36 & beyond 95 235.5 6 & beyond 86 253.1 6 & beyond 86 215.5PV of Minimum Payments 1050.9 PV of Minimum Payments 1143.6 PV of Minimum Payments 949.4
Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding
Number of Options Outstanding (shares): 1,018,716Average Time to Maturity (years): 0.00Expected Annual Number of Options Exercised: 0
Current Average Strike Price: -$ Cost of Equity: 9.00%Current Stock Price: $87.58
2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027EIncrease in Shares Outstanding: 0 0 0 0 0 0 0 0 0 0Average Strike Price: -$ -$ -$ -$ -$ -$ -$ -$ -$ -$ Increase in Common Stock Account: - - - - - - - - - -
Change in Treasury Stock 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000Expected Price of Repurchased Shares: 87.58$ 95.46$ 104.05$ 113.42$ 123.63$ 134.75$ 146.88$ 160.10$ 174.51$ 190.21$ Number of Shares Repurchased: 34,254 31,426 28,831 26,451 24,267 22,263 20,425 18,738 17,191 15,772
Shares Outstanding (beginning of the year) 443,293,348 443,259,093 443,227,667 443,198,836 443,172,386 443,148,119 443,125,856 443,105,431 443,086,693 443,069,502Plus: Shares Issued Through ESOP - - - - - - - - - - Less: Shares Repurchased in Treasury 34,254 31,426 28,831 26,451 24,267 22,263 20,425 18,738 17,191 15,772 Shares Outstanding (end of the year) 443,259,093 443,227,667 443,198,836 443,172,386 443,148,119 443,125,856 443,105,431 443,086,693 443,069,502 443,053,730
VALUATION OF OPTIONS GRANTED IN ESOP
Ticker Symbol VLOCurrent Stock Price $87.58Risk Free Rate 3.19%Current Dividend Yield 3.20%Annualized St. Dev. of Stock Returns 27.78%
Average Average B-S ValueRange of Number Exercise Remaining Option of OptionsOutstanding Options of Shares Price Life (yrs) Price GrantedRange 1 292,145 77.15 10.00 24.27$ 7,091,450$ Range 2 216,415 81.21 10.00 23.17$ 5,015,278$ Range 3 798 87.76 10.00 21.53$ 17,182$ Range 4 509,358 83.83 10.00 22.50$ 11,459,846$ Total 1,018,716 81.36$ 10.00 39.89$ 23,583,755$
