There has been a record number of dividend cuts during the ongoing coronavirus crisis, particularly in the energy sector, which is one of the most severely beaten sectors. A bright exception has been the group of U.S. refiners, which have defended its dividends so far. However, as Valero (VLO) is poised to post material losses this year, it is likely to cut its dividend, given also the uncertainty arising from the pandemic. On the other hand, the stock has been beaten to the extreme and thus it has collapsed at its 7-year lows. In this article, I will analyze why Valero has become a conviction buy around its current price.
The effect of the pandemic
The pandemic has caused an unprecedented collapse in the demand for refined products this year. According to the Energy Information Administration [EIA], the global demand for refined products is expected to slump by 8.3 million barrels per day on average this year, from 101.4 to 93.1 million barrels per day. This will mark the steepest decline in the global oil consumption in at least three decades.
In its last conference call, at the end of July, Valero stated that the demand for gasoline and diesel had recovered to 85%-90% of normal, after bottoming at 50% and 70%, respectively, in April. However, the demand for jet fuel remained 50% lower than normal. As a result, Valero planned to ran its refineries at an approximate 79% utilization rate in the third quarter. This is a daunting utilization rate, particularly for the third quarter, which is the strongest quarter for refiners in normal years.
It is also important to note that Valero generates the vast majority of its earnings from its refining business. In addition, most of its refineries are coastal and thus they lack the benefit of