You might have noticed that gas has become alot more expensive the last couple of years. One reason for that is that oil, the raw material from which gas is produced, has gotten more expensive due to growing demand around the world. The other reason is that the environmental and governmental hurdles to building a new refinery in the U.S. are prohibitive – no new refineries have been built here in the last 30 years while demand for gasoline has continued to increase. When Hurricane Katrina knocked out a good part of the nation’s refining capacity (i.e. supply) last year, gasoline prices went through the roof.
These factors will remain true into the future keeping gas prices high in the years to come. So let’s all thank Citigroup analyst Doug Leggate for cutting his ratings on the refiners in a report he issued yesterday morning (Wednesday) which sent all the refiners down.
Valero (NYSE: VLO) is the largest and probably the best independent refiner. They own 18 refineries, including 6 in Texas, 2 in Lousiana and 2 in California, with the capacity to process 3.3 millions barrels of oil a day.
The stock is trading right now at about $53.50 giving Valero a market cap of around $34 billion. Add in $4 billion in net debt and Valero has a $38 billion enterprise value. Last year (2005) Valero generated about $3.2 billion in free cash flow, which includes $2.1 billion in capital expenditures to improve and expand their refineries.
But that’s nothing compared to what they did in the 1st half of 2006. Sales are up 45% to $47.7 billion. And free cash flow, get this, is up 137% to about $1.85 billion.
Now, the 2nd half has some tough compares because of the high refining margins brought about by Hurricane Katrina in last year’s second half – about $2.45 billion of last year’s $3.2 billion in free cash was generated in the second half . But the first half is a clean compare and Valero’s business is clearly improving.
If Valero can just match last year’s second half, which the first half suggests is easily doable, that would mean $4.3 billion in free cash in 2006 which represents an enterprise value to free cash flow ratio of 8.9 for 2006. That’s an attractive price right there. And the truth is, since Valero’s business is obviously better now than last year, even though there is no Hurricane Katrina to boost refining margins, I think there is still an excellent chance that they will beat last year’s numbers making the company even cheaper.