Introduction

Despite Valero Energy (NYSE: VLO) that maintained their dividends throughout the turmoil of 2020 and the bumpy start of 2021, they were still not worth buying earlier in 2022, as my previous article discussed. Since he is released, their share price has seen a very strong rally which now sees it trading at near record highs and just over 80% higher since just the start of 2022. While this has been wonderful for their shareholders, this now leaves their shares exorbitantly expensive with the potential for significant losses, as noted in this follow-up analysis which also reviews their subsequently released results for the first quarter of 2022.

Executive summary and ratings

Since many readers are likely short on time, the table below provides a very brief summary and scores for the main criteria assessed. This google doc provides a list of all my equivalent ratings as well as more information about my rating system. The following section provides a detailed analysis for readers wishing to delve deeper into their situation.

*Instead of simply assessing dividend coverage through earnings per share cash flow, I prefer to use free cash flow as it provides the strictest criteria and also best captures the true impact on their financial situation.

Detailed analysis

The difference a year makes can be amazing, while 2021 started with a cash burn in the first quarter that saw negative operating cash flow of $52 million, the first quarter of 2022 saw the year started with a positive result of 588 million dollars. While this is a year-over-year day-and-night difference, again similar to their full-year 2021 results, their temporary working capital movements significantly skewed their results. While their full year 2021 results were helped by a large working capital drawdown of $2.225 billion, unsurprisingly this has reversed so far in 2022, with the first quarter seeing a fund build turnover of $722 million, thus seeing their underlying operating cash flow at a very strong $1.31 billion, if hypothetically removed. Despite negative free cash flow of $138 million in the first quarter of 2022, they still took advantage of their strong underlying results to accelerate their share buybacks, as management comments below. .

“And we continue to deliver on our commitment to shareholder return with an annual target payout ratio of 40% to 50%.”

“We returned $545 million to our shareholders in the first quarter of 2022, with $401 million paid out in dividends and $144 million in share buybacks, resulting in a payout ratio of 44% of adjusted net cash provided by operating activities for the quarter.”

-Valero Energy Q1 2022 conference call.

It can be seen that management continues to target returning between 40% and 50% of its adjusted net cash provided by operating activities to its shareholders, which, by the way, is effectively its operating cash flow excluding working capital movements. Besides raising questions about their balance sheet cleanup, as discussed later, it also helps to highlight how expensive their shares have become and thus, by extension, their significant downside risk when future operating conditions will almost certainly become weaker once these booming operating conditions subside.

While investors may wonder if these booming operating conditions will last through 2022 or even possibly into 2023, these record high gasoline prices and refining margins are essentially guaranteed not to last a long time in the long run, as was recently discussed in detail by a fellow author. This means that in my view, it would be wise for investors to consider whether their investment stacks up without these never-before-seen operating conditions, especially with the prospect of a federal windfall tax in the United States. .

If their very strong underlying operating cash flow of $1.31 billion in the first quarter of 2022 were notionally sustained each quarter perpetually into the future, it would annualize to $5.24 billion. Even if they were to return half of that underlying operating cash flow through dividends and share buybacks, thereby hitting the upper end of their target range, it would only provide a moderate return for investors. shareholders by approximately 4.60% given their current market capitalization of approximately $57 billion.

The prospects of seeing a relatively lackluster amount of capital repaid are not particularly desirable as they depend on their booming operating conditions, which I believe makes their current share price exorbitant. Meanwhile, seeing their operating conditions and therefore financial performance return to a more common level, such as in 2021 when their underlying operating cash flow was $3.634 billion, their shareholder return on the current cost would only be about 3.20%. In my view, this indicates significant downside risks, as these relatively low shareholder returns are unable to justify their current near-record price and therefore, after rising around 80%+ in 2022 alone, the potential for large losses of around 25% to 50% are very real when the tide turns against the refining industry and drives its stock price back to its usual levels.

Following their negative free cash flow during the first quarter of 2022, it was no surprise to see their net debt increase and after funding their $401 million in dividend payments as well as an additional $144 million in buyouts. shares, it eventually jumped from $9.748 billion at the end of 2021 to now sit at $10.523 billion. Without their working capital of $722 million, that $775 million increase would have been only $53 million.

Going forward, given that management plans to allocate between 40% and 50% to their combined dividends and share buybacks, their net debt will likely remain broadly unchanged given the capital intensity of their industry which often sees capital expenditures consume about 50% of their operation. cash flow, like in 2019 and 2021 which saw 53% and 42% respectively. Interestingly, this runs counter to their deleveraging objective that was discussed in the previous analysis, which is apparently continuing, per the management commentary included below.

“We want to continue to pay down debt. We’ve paid down $2 billion in the last 6 months. And also – certainly on our commitment to our shareholders with the buyout.”

“We’re pretty comfortable with our 20% to 30% range. It definitely gives us some leeway to go a lot lower than we are right now. I believe we’re at 34% now. We have so still a few ways to get down to our — the upper limit of our goal. And of course we can do that by holding cash or paying down debt.”

-Valero Energy Q1 2022 conference call (previously linked).

While it’s clear that they’re allocating the majority of their cash flow elsewhere, oddly management continues to discuss deleveraging, which, to say the least, is rather confusing with seemingly disjointed priorities. While the outlook for limited deleveraging is not problematic at this time as it generates ample free cash flow, it does increase downside risks going forward when these booming operating conditions become weaker again. Since only a quarter has passed since the previous analysis and their capital structure is not significantly different, it would be redundant to reassess their leverage and liquidity in detail.

The two relevant graphs have always been included below to provide context for any new reader, which show a net debt to EBITDA ratio of 1.32 and a net debt to operating cash flow of 2.00, both at thus in the low territory between 1.01 and 2.00. Meanwhile, their respective current and cash ratios of 1.18 and 0.13 continue to point to strong liquidity, despite a slight decline from their respective previous results of 1.26 and 0.24 at year-end. 2021. If you want more details on these two topics, please refer to my previously linked article.

Conclusion

While their stock price may continue to rise in the weeks and months ahead, investors would be wise to remember that just like trying to pick the bottom, it is also effectively impossible to pick the top. Given that their expected shareholder returns, even at the upper end of their target range, are relatively lackluster despite these booming operating conditions, this leaves their shares priced exorbitantly. Also considering the potential for large losses of around 25% to 50% in the future when this refining boom almost certainly returns lower, I now think it is appropriate to downgrade to a sell rating.

Notes: Unless otherwise stated, all figures in this article are taken from Valero Energy’s SEC Filingsall calculated figures were performed by the author.