Valero Energy Corporation (VLO): Time to Catch This Refiner Before It Reaches Fair Value

Oil prices have been volatile over the last year, due to which profiting from the oil sector (especially refining sector) has been quite challenging. But shares of Valero Energy Corporation (NYSE:VLO) have more than doubled over the last year and could continue to soar.

Value unlocking

In a bid to unlock shareholder value, Valero Energy Corporation (NYSE:VLO) recently decided to spin off its retail division, CST Brands, which began trading last month.

CST Brands is an established chain with nearly 1,900 stores, which retails transportation fuels and convenience goods across Canada and the U.S. The retail division collected $13.1 billion in revenue last year, making it the second largest publicly traded convenience retailer in the U.S. To continue growing, the company has plans to open 38 new stores across Canada and the U.S in 2013. Besides that, CST Brands would also be launching its largest retail store this month, with an area of around 10,100 sq. ft.

To fund the spin off, CST Brands raised $1.05 billion through bond offerings and undertook $500 million worth of loans, which would eventually flow to Valero Energy Corporation (NYSE:VLO) as cash proceeds.

The spin-off would allow Valero Energy to perform in line with the Brent-WTI spread, which determines refinery margins. But the Brent-WTI spread has declined by over 60% since February, primarily due to excessive refinery output and relatively weaker crude demand. In my opinion, this would be a great time to pick refinery stocks, as the spread is expected to improve due to rising Indian and Chinese crude imports over the short-term period.

Peer talk

On the refining side, Valero Energy Corporation (NYSE:VLO)’s most notable competitor is HollyFrontier Corp (NYSE:HFC).

On comparing the metrics, it’s not hard to see that HollyFrontier Corp (NYSE:HFC) carries a higher yield due to its relatively higher payout ratio. Although both companies appear to be undervalued on a forward earnings basis, Valero Energy appears undervalued even with respect to its growth prospects.

With that said, HollyFrontier Corp (NYSE:HFC) is a great company with an impressive net profit margin and low debt levels. The company operates with a refining capacity of around 443,000 barrels-per-day, and recently ramped up its refining capacity at its Wood Cross facility by 13.85%. Considering its growth prospects, HollyFrontier appears to be more of an income growth stock rather than a value play.

However, Valero Energy Corporation (NYSE:VLO) appears to have a huge upside due to the CST Brands spin off. Besides the cash benefits, Valero Energy should see significant improvement in its net profit margins and this should bring it at par with its refinery peers. As a result of value unlocking, analysts at Barclays have suggested a price target of $72 for Valero Energy Corporation (NYSE:VLO).