In looking for investment ideas in a market that has made multiple new highs recently, I like to look at the Sector and Industry Group ETFs to see where the institutional money has been going. The S&P Select Sector SPDR Energy ETF (XLE) and the S&P SPDR Oil & Gas Exploration and Production ETF (XOP) have both been outperforming the market over the past 2 months.
One of the leaders in the (XOP) has been oil refiner Valero Energy (VLO). VLO has been the beneficiary of the favorable spread between domestic crude oil and foreign crude oil prices. This is known as the WTI – Brent Crude spread, and Valero has been a prime beneficiary because of its extensive U.S. Gulf Coast holdings. The ability to access lower cost Gulf Coast crude oil has led to improved profit margins for Valero. Any escalation in the Russian/Ukrainian situation would likely work to VLO’s advantage, and analysts have been raising their 2nd quarter estimates for Valero for the past 8 weeks after their 1st quarter earnings report blew through analyst estimates.
VLO has a very bullish Chaikin Power Gauge rating driven by strong and consistent earnings performance, increasing analyst opinions and the strength of the Oil & Gas Exploration & Production Group. VLO has bested analyst’s estimates in 7 of the past 8 quarters. Consensus earnings estimates for the 2nd quarter are $2.02 vs. $0.90 a year ago. The full year consensus estimate is $6.75 a hefty increase over last year’s $4.42 per share. This is all well known to investors, however, so why buy VLO now?
The reason is that even without sanctions on Russia, the explosive growth of the burgeoning shale oil industry and new crude oil production from the Gulf of Mexico gives Valero access to relatively inexpensive crude stocks as West Texas crude (WTI) is expected to fall in price over the next year. New pipelines are delivering cheap U.S. shale oil to Valero’s Gulf Coast refineries. Valero also has a very strong balance sheet with cash expected to exceed $5 billion by 2015. The combination of the divestiture of 80% of its retail operations, the formation of an MLP, Valero Energy Partners LP (VLP), and a strong increase in operating cash flow has improved VLO’s balance sheet.
This should enable Valero to significantly increase its dividend from the current 1.77% level as well as spend approximately $ 1 billion a year on share repurchases. Analysts at Cowen & Company, Oppenheimer and Barclays have recently increased their price targets to the 70 – 75 range, excellent upside potential from the 56.05 close on Friday, May 30, 2014.
The stock has reversed from a short-term oversold and triggered a Relative Strength Breakout Buy signal in Chaikin Analytics. With the market continuing to grind out new highs in the larger capitalization stocks and the favorable fundamentals for this diversified independent oil refiner, VLO is an excellent long term buy at current levels.