Americas: Energy: Oil - Integrated: Integrated Oil and Refining Trading Update
Goldman Sachs Note October 14, 2007 United States
Refiners bounce, "shoulder months" stats manageable
1. VLO pre-announces negatively, yet shares rally. It is not often that a stock rallies 3% on the day of a meaningful negative EPS pre-announcement that came after two solid up days. Valero Energy (Conviction Buy rated), however, pulled off the rare feat this past Wednesday, as the shares shrugged off a further downward adjustment to already lowered 3Q 2007 expectations. Given the pre-announcement, we have lowered our 3Q 2007 EPS estimate to $1.35 from $1.75. Our full-year 2007 EPS forecast is now $8.51 versus $8.90 before. We have made no change to our 2008-2012 EPS forecasts, with our 2008 and 2009 forecasts of $13.50 and $17.20, respectively, considerably higher than consensus.
2. VLO's surprising stock reaction indicative of low expectations. We see Valero's stock action as consistent with our view that expectations for refiners were already very low, a point supported by our "convergence trade"-style regression analysis that looks at Valero shares (adjusted for the level of the S&P 500) relative to 1-year strip Gulf Coast 3:2:1 refining margins and 2-year strip WTI oil prices. In fact, in three days the stock closed about half of the gap with fair value that we highlighted in last week's "trading update" note. The fact that fair value in our convergence trade regression is relative to current strip margins--which we believe are depressed relative to current oil prices--in our view explains how Valero can rally at a time near-term EPS expectations have been reduced. In fact, there is still about 7% upside to fair value based on current depressed strip margins. Given our bullish outlook for 2008-2009 refining margins, we see considerably more upside in Valero shares over the next 12 month as margins re-couple with oil prices post the current seasonally weak period.
3. During 4Q, we would add to VLO/refiners when trading below "fair value" based on regression that considers current depressed strip margins. With 4Q normally a seasonally lackluster period for refining margins, we are comfortable adding to refiners when trading below "fair value" using our regression analysis. Assuming no change in the level of the S&P 500, we would be comfortable buying Valero up to the $80 level, with the shares especially attractive below $75 and a Buy below $70. |
