Published on March 22nd, 2022 by Aristofanis Papadatos
As inflation has surged to a 40-year high this year, it has become challenging for income-oriented investors to protect the real value of their portfolios from eroding. Many investors have resorted to high-yield stocks but these stocks warrant special attention, as there are usually good reasons behind their attractive yields.
You can download your free full list of all high dividend stocks with 5%+ yields (along with important financial metrics such as dividend yield and payout ratio) by clicking on the link below:
Despite its breathtaking rally since late 2020, Valero Energy (VLO) remains a high-yield stock, with a 4.2% current dividend yield.
Nevertheless, due to the dramatic cycles of the refining business, investors should not purchase Valero without performing their due diligence. In this article, we will analyze the prospects of this high-quality refiner.
Valero is the largest petroleum refiner in the U.S. It owns 15 refineries in the U.S., Canada and the U.K. and has a total capacity of approximately 3.2 million barrels per day. It also produces renewable diesel and has a midstream segment, Valero Energy Partners LP, but its contribution to total earnings is under 10%. Valero should be viewed as a nearly pure refiner.
All the U.S. refiners faced a fierce downturn in 2020-2021 due to the coronavirus crisis, which caused an unprecedented collapse in the demand for refined products. According to the Energy Information Administration (EIA), global demand for refined products decreased 9% in 2020, from 101.2 million barrels per day in 2019 to 92.0 million barrels per day.
That decrease caused a collapse in refining margins and all the U.S. refiners incurred material losses in 2020. Valero was not an exception, as it posted its first loss in more than a decade in that year.
However, thanks to the massive distribution of vaccines worldwide, the pandemic has begun to subside in recent months. Global oil consumption surged to 97.5 million barrels per day in 2021. Moreover, it is expected by the EIA to grow by another 3.2% this year, to 100.6 million barrels per day, and return to its pre-pandemic level next year.
Valero has already begun to show signs of a strong recovery from the pandemic. In the fourth quarter of 2021, the company increased its refinery throughput 20%, from 2.5 million barrels per day in the prior year’s quarter to 3.0 million barrels per day. In addition, the refiner enjoyed much wider refining margins thanks to the aforementioned recovery of the demand for oil products. As a result, its refining segment switched from an operating loss of -$476 million in the prior year’s quarter to operating income of $1.1 billion.
As the refining segment of Valero is by far its most important segment, the company switched from an adjusted loss of -$1.06 per share in the prior year’s quarter to a profit of $2.47 per share. It thus exceeded the analysts’ estimates by an eye-opening $0.65. Notably, it was the most profitable quarter for Valero in at least 7 years.
Moreover, Valero continues to thrive thanks to robust demand for oil products and low inventories of light distillates, especially gasoline. It also benefits from the permanent shutdown of some refineries around the globe in the last two years due to the pandemic. As a result, Valero currently enjoys multi-year high refining margins.
The energy sector is characterized by extremely high cyclicality, which is caused by the dramatic swings of the price of oil. To be sure, the price of oil dived into negative territory for the first time in history about two years ago, when some analysts were calling for the “end of oil as we knew it” amid a major shift from fossil fuels to renewable energy sources. Not only did those analysts prove wrong, but the price of oil has now surged to a 13-year high, mostly due to tight global supply.
Given the cyclicality of its business, it is only natural that Valero has exhibited a volatile performance record. Notably, due to the impact of the pandemic on its business, the company has incurred a decrease in its earnings per share over the last decade.
On the bright side, Valero is doing its best to affect the factors it can control. More precisely, it invests in projects that enhance its refining margins on a regular basis. In addition, the company is heavily investing in the expansion of the capacity of its renewable diesel production in order to adjust to the secular shift of the world towards cleaner energy sources.
The vehicles which use renewable diesel exhibit approximately 40% fewer emissions than electric vehicles, as the electricity of the latter is generated primarily from fossil fuels. Therefore, the focus of Valero on renewable diesel makes great sense.
Overall, thanks to a promising pipeline of high-return growth projects, Valero expects to grow its annual EBITDA by $1.2-$1.7 billion in the upcoming years.
Source: Investor Presentation
As Valero has generated average adjusted EBITDA of $6.4 billion since 2012, it is evident that its ongoing growth projects will significantly enhance its profitability in the upcoming years.
Valero has a significant competitive advantage over its peers, namely the high complexity of its refineries, which enables the company to take advantage of the swings of the prices of the various types of crude oil and refined products.
As the company optimizes its blend of feedstock and products, it can achieve greater profits than simple refineries, which are much less flexible.
On the other hand, investors should always keep in mind that refining is a highly cyclical business, which is vulnerable to recessions and periods of excessive supply of oil products.
During the Great Recession, refiners incurred negative refining margins and thus posted material losses. The same was evidenced in 2020 as well, due to the impact of the pandemic on the global demand for oil products.
Valero is currently offering a 4.2% dividend yield. The company grew its dividend for 10 consecutive years, until 2021. Due to the pandemic, the company has frozen its dividend for nine consecutive quarters.
Valero has a forward payout ratio of 63%, which is not extreme but is elevated, particularly given the cyclicality of the refining business and the continuous need to spend hefty amounts on maintenance and growth projects.
On the bright side, interest expense has consumed 27% of operating income in the last 12 months while net debt stands at $23.5 billion, which is only about four times the expected earnings this year.
Overall, Valero has a healthy balance sheet and its dividend is safe in the absence of a major downturn in its business. Nevertheless, given the high cyclicality of refining, the dividend of Valero is likely to come under pressure whenever the next downturn shows up.
Even if the current favorable conditions persist for years, which is unlikely, investors should not expect material dividend hikes going forward.
Valero is a high-quality refiner, which is thriving right now thanks to strong pent-up demand for oil products amid tight supply.
However, the stock has rallied 150% since late 2020 thanks to the impressive recovery of this business from the pandemic.
As a result, the stock has become fully valued and investors should wait for a meaningful correction before purchasing it.
If you are interested in finding more high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be useful:
- The 20 Highest Yielding Dividend Aristocrats
- The Dividend Kings List is even more exclusive than the Dividend Aristocrats. It is comprised of 40 stocks with 50+ years of consecutive dividend increases.
- The 20 Highest Yielding Dividend Kings
- The Dividend Achievers List: a group of stocks with 10+ years of consecutive dividend increases.
- The Dividend Champions List: stocks that have increased their dividends for 25+ consecutive years.
Note: Not all Dividend Champions are Dividend Aristocrats because Dividend Aristocrats have additional requirements like being in The S&P 500.
- The Dividend Contenders List: 10-24 consecutive years of dividend increases.
- The Dividend Challengers List: 5-9 consecutive years of dividend increases.
- The Monthly Dividend Stocks List: contains stocks that pay dividends each month, for 12 payments per year.
- The 20 Highest Yielding Monthly Dividend Stocks
The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them regularly: