Energy sector's winner

October 20, 2015 01:00 PM

Crude oil prices have plummeted over the last year. The U.S. Oil exchange trade fund (USO) declined 60% in the last year and 28% in the three-month period ending Aug. 18. Beyond oil companies, we can see that the Energy Select Sector SPDR ETF (XLE) is down 30% in the last year as well.

As the price of oil has deteriorated, so have the major oil drillers and explorers. Exxon Mobil (XOM) is down 22%, ConocoPhillips (COP) is down 40% and Chevron (CVX) is down 35% in the last year. Every stock has been a loser, or have they?

Out of 250 companies in the sector, there is one large cap (and only one) diamond in the rough. Valero Energy (VLO) has a four-star rating from Capital Market Laboratories.

For crude oil to be useful, it must be refined into gasoline, diesel, jet fuel or propane. Unlike the companies that specialize in the exploration and production of oil and gas, refiners’ profits are not subject to the whim of crude oil prices, which is unique in the sector. 

Valero is the largest independent refining company in North America, with a throughput capacity of 3.3 million barrels per day. The stock is up nearly 29% in the last year and 16% in the last three-months, outpacing XLE, the S&P 500 and the Nasdaq Composite.

Shrewdly, Valero increased its capital expenditures substantially from 2010 through 2012. Those investments increased VLO’s refining efficiency and capacity. Valero spent $1.7 billion in 2010 and $2.9 billion in 2012. Valero has since cut expenditures by 30%. Further, while Valero revenue is down, it has increased operating margins, net income and levered free cash flow. These  are phenomena that have pushed the stock higher.

While trailing 12-month (TTM) revenue for Valero is down, TTM net income is up substantially, with 50% year-over-year growth. “Income rules” plots TTM revenue (blue bars) and net income (orange line). Note the strong upward trend in earnings. 

Valero generates $1.09 in revenue for every $1 in operating expense.  Last year, this measure stood at $1.03, meaning that as oil prices collapsed, Valero realized a nearly 6% increase in margins. 

TTM levered free cash flow is a critical determinant of stock price because market cap is the present value of all future free cash flows. Valero has seen levered free cash flow rise to an astonishing $3.9 billion, an 88% year-over-year rise. That $3.9 billion is a seven-year high. Again, this is happening with collapsing commodity prices.

“Cash is king” plots TTM levered free cash flow (blue bars) and operating revenue over operating expenses (orange line). We take this time series back to the beginning of 2009, when Valero was realizing negative free cash flows of over $1 billion.

The bottom line is, while the energy sector in general and the oil industry in particular have suffered through collapsing commodity prices, Valero stands head and shoulders above the rest. The company made massive investments in capital and is now reaping the benefits.

About the Author

Ophir Gottlieb is the co-founder/CEO of Capital Market Laboratories ( He is a former option market maker and the co-inventor of the Forensic Alpha Model and Governance Risk Models used by asset managers worldwide with over $1T AUM. Gottlieb’s mathematics and machine learning background stem from his graduate work at Stanford University. @ophirgottlieb