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No. of Recommendations: 24
Refineries are really tough to value. Earnings swing wildly, making things like P/E almost meaningless. Book value can be all over the map, depending on what price people are willing to pay to add capacity.

Yet, I think Valero is worth a look right now.

Current market cap is: $13.1 B
Total debt: $7.65 B
Total cash: $2.83 B
Enterprise Value: $17.98 B

Value of refining assets:
In one of my most painful lessons as an investor, I was working for Tesoro when the stock bottomed around $1.70 per share back in 2002. Risk was that they would go bankrupt. I kept thinking that all they'd have to do is sell their refineries and they'd be able to pay off all the debt and have $4/5 per share left over. It was a screaming value.

I thought, "why not take a risk with a small position?" I didn't. The stock turned into a 70-bagger before the recession hit. Ouch.

Today, Valero is not nearly the same screaming deal, but the risks are also much lower.

Valero has 16 refineries. 13 in the U.S., 1 in Canada, 1 in Europe, 1 in Aruba. Total throughput is about 3 million barrels per day (bpd). They also own several ethanol plants, along with terminals and convenience stores.

That said, refining will clearly be the driver of the business.

The company value is currently about $6,000 per bpd capacity.

To put this in perspective, it costs about $18,000 per bpd to expand capacity and $27,000 to build new. However, recent sales of refineries on both sides of the Atlantic have been at lower prices than the above.

Valero, in fact, sold their Paulsboro and Delaware City refineries for about $3,000 per bpd during the recession (Delaware City sold for even less because it was already closed).

Profile of current capacity
That said, all capacity is not created equally. Refining needs scale to be profitable and flexibility in feedstock. The current profile of
Valero's refineries is relatively complex with about 2/3 of their capacity capable of handling mid-to-heavy sour crudes. This is the crude that is at a significant discount to the quote you see on the news every night.
Valero is also spread over a wide geographic range, with some access to oil from the Cushing terminal (for which pipeline capacity is inadequate causing this oil to be significantly discounted to global rates).

Valero now only has 2 relatively small refineries--Ardmore, OK and Three Rivers, TX. Ardmore is perfectly placed to benefit from the Cushing discount and is probably making over $1/day in profit. Until new pipelines are constructed, this market anomoly will remain--i.e. likely for years.

Valero has the scale, geographic diversity, and crude stock diversity so that it can be seen as essentially a proxy of the refining industry.

Drivers that will make the stock go up will be falling crude prices, constrained refining supply, and economic recovery which spurs additional demand.

Falling Crude Prices
* Actually more probable than most people think. There is a ton of new capacity coming on line in the U.S., Canada, Brazil, offshore Africa, and maybe Iraq. Geopolitical tensions and risks aside, the high prices of the past decade have created a big incentive to drill.

* Constrained refining supply. More refineries are going out of business. The 500,000 bpd refinery on St. Croix just announced they are closing. That's the largest refinery in the Western Hemisphere. Several other smaller players have closed as well. No new refineries are being built, although a few projects have recently come on line or are coming on line to increase supply. Call it a draw.

* Economic recovery. Upside is certainly possible.

Worth keeping an eye on and consider buying if there is another dip. Even in the depths of the recession, Valero didn't stay below $20/share very long.

Also need to do some due dilligence on management/corporate governance.

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