Benicia visit reinforces bullish refining view, with VLO our top pick - Goldman Sachs - July 10, 2007
What's changed
We visited Valero Energy management at its Benicia (California) refinery on July 9. We came away from our visit with a better understanding of the major challenges all of the industry faces in running refineries at sustained high utilization rates. We believe overall US refinery utilization rates are likely to be 3%-5% lower going forward than was the case for much of the past decade, which supports our above-consensus refining margin outlook. We would characterize ongoing utilization as more likely to be in the low-90%s in the future versus a mid-90%s utilization most have thought of as a sustainable rate and was the experience prior to Hurricane Katrina in 2005.
Implications
Consistent with our bullish refining margin outlook, our EPS estimates for Valero and other refiners remain way above consensus for 2007-2009. For Valero, we are 28%, 58%, and 66% above the corresponding First Call consensus estimates for 2007, 2008, and 2009 based on a Gulf Coast 3:2:1 refining of $15/bbl in 2007 and $12/bbl in both 2008 and 2009. We think risk to our margin forecasts, especially for 2008-09, is skewed to the upside.
Valuation
We see 37% upside potential to our $105 12-month price target for Valero, which is based on P/E, cash-flow, and asset valuation analyses.
Key risks
A sustained decline in refining margins to levels below $8/bbl for the benchmark Gulf Coast 3:2:1 (WTI) refining margin.
Impact on related securities
We also have a Buy rating on Marathon Oil, primarily for its refining leverage. Our favorite Neutral-rated refining company is Sunoco. Given our Attractive coverage view we would expect other Neutral-rated refining-leveraged companies to perform well, such as Tesoro and Frontier Oil. |
