High Operational Efficiency And Renewable Fuel Growth Clash With Market Challenges And Analyst Skepticism

Key Takeaways

• High throughput capacity utilization and exceeding sales targets signal operational efficiency and strong demand, promising revenue growth without specifying figures.
  
• Commitment to renewable energy and shareholder returns through sustainable aviation fuel projects and a high payout ratio indicates growth prospects and financial confidence.
  
• Valero Energy faces risks from market dependencies, operational challenges, regulatory changes, demand shifts, and competitive pressures in renewable diesel, affecting stability and growth.

Catalysts

Manufactures, markets, and sells petroleum-based and low-carbon liquid transportation fuels and petrochemical products in the United States, Canada, the United Kingdom, Ireland, Latin America, Mexico, Peru, and internationally.

• Throughput capacity utilization at 94% and sales exceeding targets indicate operational efficiency and high demand, which could drive revenue growth.
  
• The Diamond Green Diesel sustainable aviation fuel project is expected to make Valero one of the largest manufacturers of sustainable aviation fuel, enhancing future growth prospects in renewable energy and potentially increasing profit margins.
  
• Commitment to shareholder returns with a high payout ratio signifies confidence in continued strong financial performance and potential to increase earnings per share through buybacks.
  
• Limited announced capacity additions beyond 2025 suggest less competition and favorable supply dynamics, potentially supporting long-term refining margins and revenue.
  
• Expansion in renewable diesel and ethanol segments despite planned maintenance activities shows resilience and diversification of income streams, likely enhancing net margins and reducing volatility in earnings.

Assumptions

• Analysts are assuming Valero Energy's revenue will decrease by -5.5% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 4.4% today to 3.0% in 3 years time.
• Analysts expect earnings to reach $3.4 billion (and earnings per share of $11.74) by about August 2027, down from $5.9 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $5.4 billion in earnings, and the most bearish expecting $3.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 14.9x on those 2027 earnings, up from 8.0x today. This future PE is greater than the current PE for the US Oil and Gas industry at 9.9x.
• Analysts expect the number of shares outstanding to decline by 9.27% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.43%, as per the Simply Wall St company report.

Risks

• Dependence on the heavy sour crude market and its pricing dynamics could lead to variable refining margins, potentially impacting revenue stability.
  
• Operational challenges and planned maintenance activities in the refining and renewable diesel segments might lead to production downtimes, affecting overall output and profitability.
  
• Wider economic and policy changes, especially relating to energy, renewable fuels, and carbon capture initiatives could introduce regulatory risks and costs, impacting net margins.
  
• Global demand shifts, particularly in key markets such as China or due to changing fuel standards, could unpredictably affect demand for Valero's products, impacting revenue.
  
• Competitive pressures in the renewable diesel market, including feedstock availability and pricing, could challenge growth expectations and affect profit margins in this segment.

Valuation

• The analysts have a consensus price target of $171.23 for Valero Energy based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $192.0, and the most bearish reporting a price target of just $128.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $113.5 billion, earnings will come to $3.4 billion, and it would be trading on a PE ratio of 14.9x, assuming you use a discount rate of 7.4%.
  
• Given the current share price of $147.64, the analyst's price target of $171.23 is 13.8% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.