Valero Energy Corporation - Case Study Example

November 14, 2016

Instructor

Valero Energy (VLO) - Financial Company Analysis

• Company description

Valero Energy Corporation (VLO) is one of the leading global manufacturer and marketers of petroleum products and power. Valero has its headquarters in San Antonio, United States with its subsidiaries in United States, Canada, United Kingdom, Ireland and the Caribbean (Valero, 2016). The company has its main operations in the United States and Canada and it operates under the umbrella of oil refining and marketing industries. Valero Energy being a fortune 500 company was incorporated in the year 1981 as Valero Refining and Marketing Company which later in the year 1997 transitioned to Valero Energy Corporation, it is involved in refining and ethanol segments (Ontario Securities Commission, 2013). The company is listed in the NYSE using the symbol VLO.

Valero Energy has 15 petroleum refineries based in the United States, Canada and United Kingdom as well as 11 ethanol plants in most parts of the United States (Valero, 2016). As of January 2016, Valero had approximately 10,103 employees (United States Securities and Exchange Commission 2015). The products offered by Valero Energy include; petrochemicals, lubricants, gasoline products, diesel, jet fuel, asphalt and other refined products. The company has its markets in the US, UK, Canada, Caribbean and Ireland through it’s over 7,500 outlets that bear its brand name (Ontario Securities Commission, 2013).

The company is faced by some major risks which includes the volatility of the refining margins which affect the financial figures reported in the financial statements (United States Securities and Exchange Commission 2015). Secondly, the changes in the environmental laws have an adverse effect on the business performance since the company is expected to comply with the laws set. Additionally, competitors possess a risk since some of them have huge financial resources thus a higher competitive advantage.

• Overall trend assessment

Trend assessment on the income statement and the balance sheet helps to assess the financial performance of the company over a given period of time (Healy, & Palepu, 2012). For the purpose of this analysis, we will consider the income statement and balance sheet of Valero Energy for five years (2011-2015). The trend percentages are obtained for each item in the financial statements using 2011 as the base year as shown in the excel output.

• Trend assessment for the income statement

The value of sales increased by 11% in 2012, then dropped by 1% in 2013. There was a further decrease by 5% and 33% in the year 2014 and 2015 respectively (Valero 2011-2015). Net income on the other hand, is increasing significantly by 33% in 2014 and 10% in 2015 while the expenses increased by 56% in 2012 due to higher selling, administrative, depreciation and amortization expense which later decreased by 25% in 2013 and further 3% in 2014. This resulted in an increase in operating income.

• Trend assessment for the balance sheet

The total current assets experienced an upward trend by 3% in 2012 and 17% in 2013 which means that the company has a better liquidity position while the downward trend by 14% in 2014 and 10% in 2015 is caused by lower liquidity position (Li, Lundholm, & Minnis, 2012). The common stock maintained a constant trend thus there was no issuance of shares during the 5 years. The retained earnings increased by 11% in 2012 and 2013 respectively followed by a slight increase of 14% in 2015 which is due to increase in net income and also there was no payment of dividends to shareholders (Valero, 2011-2015). The percentage change in current assets is higher than the percentage change in current liabilities for the four years which implies that there are more current assets compared to current liabilities.

• Ratio trend analysis

Ratio analysis is another key tool in assessing the financial statements of the company so as to ascertain the overall financial performance, efficiency and liquidity of the company over a particular period of time (Brigham, & Ehrhardt, 2013). We will analyze different ratios for Valero Energy under the five major classifications over the three year period. A comparison with two of the company’s competitors; Exxon Mobil Corp and BP Plc. will be performed.

• Liquidity ratios

The liquidity ratios measures the ability of a company to pay back its liabilities using its current assets when they fall due (Weygandt, Kimmel, & Kieso, 2015). The liquidity ratios calculated in excel for Valero such as the current ratio increased from 1.47 in 2013 to 2.03 in 2015 which means that the company had more current assets compared to current liabilities in 2015 thus a better liquidity position. Both its competitors recorded lower liquidity ratios for the three years which implies that Valero has a high ability to pay its short-term obligations using current assets compared to Exxon and BP.

• Financial leverage ratios

Financial leverage ratios also known as gearing ratios are the ratios that determines the company’s financial risk due to the use of debt (Zack, 2013). Total debt to assets ratio and debt to equity ratio for Valero showed a decreasing trend of 0.52 in 2015 compared to 0.58 in 2013 which means that the financial risk was lower in 2015. However, Exxon and BP had an upward trend for the two ratios which means that their financial risk increased from 2013 to 2015. In addition, Valero had a higher times interest cover of 14.68 times in 2015 compared to 10.86 times in 2013 which means that the company had a higher ability to pay its interest expense using it’s EBIT in 2015. This is not the case for the two competitors since they have a lower times interest cover compared to Valero.

• Turnover ratios

Turnover or activity ratios measures the efficiency of a company to utilize its assets to generate sales revenue (Weygandt, Kimmel, & Kieso, 2015). The accounts receivable turnover for Valero was 17.68 times in 2014 which implies that the company utilized it accounts receivable more to generate sales in 2014. Inventory turnover ratio was 22.44 times in 2013 which shows high efficiency in converting inventories into sales. Similarly, it took Valero fewer days to collect its debt in the year 2014 as depicted by the DSO ratio of 20.64 days similar to 19.73 days of Exxon while BP took few days (26.94 days) to collect debt in 2015. However, Exxon was more efficient in 2014 to generate sales from accounts receivable and inventory while BP more efficient in 2015 to generate sales from accounts receivable.

• Profitability ratios

Profitability ratios determines the management’s ability to control various expenditure incurred by the company (Zack, 2013). From the excel analysis, Valero had higher profitability ratios such as the net profit margin of 4.54% in the year 2015 which implies that they generated more returns in 2015. This is different from BP since they incurred a loss in 2015 and the profitability in 2014 and 2013 was significantly low while Exxon had a higher profitability in 2014 as evidenced by a net profit margin of 7.89%.

• Market value ratios

Market value ratios also known as equity ratios are used to measure the overall performance and the going concern of the company (Vandyck, 2006). Valero had a higher EPS of $7.98 in 2015 which means that for every share held, the company’s investors received a higher return in 2015. BP made a loss in 2015 and therefore EPS was higher in 2013 while investors in Exxon received a higher return of $7.60 in 2014. Based on the dividend cover calculated for Valero it is evident that in 2015 the company had more earnings to pay out dividends to its shareholders (Wild, Bernstein, Subramanyam, & Halsey, 2004). Exxon and BP had low value of dividend cover compared to Valero.

• Stock price and EPS analysis

The stock price of Valero energy was $59.37 in 2015 compared to $56.58 in 2013 which shows a slight increase in the price. An increase in stock price is occasioned by many people buying the stocks thus pushing the price upwards; demand for stocks is higher than supply (Shctyne, Fridson, & Alvarez, 2012). The price earnings ratio (P/E) for had a downward trend in from 11.40 in 2013 to 7.44 in 2015 which is not a favorable trend for the investors since they are not assured of an improved performance in the future. Exxon had a low in P/E of 11.60 in 2014 which later increased significantly to 16.40 in 2015 therefore the investors of the company are optimistic of a better performance in the future. BP performed better in 2014 with a P/E ratio of 12.70.

The earnings per share (EPS) for Valero energy had an upward trend from $4.96 in 2013 to $7.98 in 2015 compared to a decrease for Exxon in 2015 for $3.85 from $7.37 in 2013. However, due to a loss that was recorded in 2015, the EPS was negative, but a higher EPS was recorded in 2013. The current beta for Valero from the excel computation is 1.34 which indicates that the stock prices are more sensitive than the market index (Thukaram, 2003). The competitors; Exxon has a beta of 0.86 and BP has a beta of 1.16, both competitors have a lower beta compared to Valero but it is important to note that Exxon has a beta less than 1 which shows that the stock prices of Exxon are less sensitive than the market index.

• Capital structure analysis and WACC

The capital structure which is given by debt to equity ratio for Valero was 1.08, 1.14, 1.37, 1.46 and 1.60 in 2015, 2014, 2013, 2012 and 2011 respectively. During the five year period the ratio was greater than 1 which implies that the company relies more on debt to finance it projects compared to equity (Ali, Yadav, & Jamal, 2013). There was a significant change in 2015 compared to 2011 due to a reduction in total debt.

WACC calculation

Beta = 1.34 (obtained in the excel output for the period from January 4 2016 to November 21, 2016)

Dividend growth = 4%

Market premium = 6.4%

Risk-free rate = 1.71%

Price per share = $59.37

Tax rate = 31.3%

Dividend per share = $0.85

Capital structure: 1.08:1. This is obtained as the debt to equity ratio calculated in excel

• Security market line approach

WACC = * cost of equity + * (1 – tax rate) * cost of debt

Cost of equity = risk-free rate + beta * market premium

= 1.71% + 1.34 * 6.4%

= 10.29%

Cost of debt = interest expense / long term debt

= 433 / 7,250

= 5.97%

WACC = (100% * 10.29%) + (108% * 5.97% * (1-0.313))

= 14.72%

• Dividend growth model approach

WACC = * cost of equity + * (1 – tax rate) * cost of debt

Cost of equity = (expected dividend / share price) + growth

= ($0.85*(1+0.04) / $59.37) + 4%

= 5.49%

Cost of debt = interest expense / long term debt

= 433 / 7,250

= 5.97%

WACC = (100% * 5.49%) + (108% * 5.97% * (1-0.313))

= 9.92%

Security market line approach has a higher WACC (14.72%) compared to dividend growth model approach (9.92%).

Advantages of security market line approach

• It incorporates systematic risk (beta)
• It is considered one of the best method for computing the cost of equity for a company

Disadvantages of security market line approach

• It is a single period model
• It is based on unrealistic assumptions such as the existence of risk-free rate.

Advantages of dividend growth model approach

• Simple to use and understand

Disadvantages of dividend growth model approach

• Can only be used in dividend paying companies
• It ignores risk
• Statement of cash flow analysis

The net cash from operating activities increased from $4,038 in 2011 to $5,564 in 2013 after which it dropped slightly to $4,241 in 2014 which represents the cash generated internally from the company’s operations. Net cash from investing activities represents cash outflow, the decrease for the five year period was mainly as a result of purchase of property & equipment. The net cash from financing activities experienced an upward and downward trend due to dividend payment and changes in debt levels. From the excel output, the statement of cash flows shows that free cash flow increased from $1,683 in 2011 to $3,993 in 2015 which implies that the company has cash after incurring capital expenditures. Free cash flow equals to operating cash flow less capital expenditure.

• Conclusion

In conclusion, the overall financial performance of Valero Energy Corporation has shown an increasing trend over the years as evidenced by the ratio analysis of the company, the company’s profitability, efficiency and liquidity positions of the company are commendable in comparison to Exxon and BP. This trend helps to attract more investors in the company since there is hope for better performance in the future years (Gibson, 2012). Valero energy has the ability to meet its short-term obligations but the management should reduce heavy reliance on debt financing so as to reduce financial risk in the future. The company should also strive to reduce on expenditure incurred so as to maximize on profits generated hence higher returns for its shareholders. Similarly, the capital structure should have more equity than debt.