Valero Energy Corporation (VLO) Earnings Call Transcript & Summary

First of all, thanks, Joe, Lane, thank you, and the entire Valero management for coming to Vail. It's tough times, but thank you so much for coming up. When you show up, you tell the world you are open for business, and I think that matters a lot. So with that, I would like to present Valero.

Thank you. Thanks, Manav. And thanks, everybody, for coming. Interesting period, huh? Awful week last week. But the sun is shining, and the sun will shine again. This thing -- it's hard to figure out how serious this coronavirus deal is. And we can talk more about the effects we've seen on our business, and we should do that, but it just seems like we're living in a world today where everything gets overhyped. IMO is probably overhyped. This coronavirus thing may turn out to be a real serious issue. But right now, it doesn't seem to be all that bad, but we're reacting like the world is going to end. And then we got the political situation. We've got Chinese tariffs. We've got Venezuelan sanctions, Iranian sanctions, OPEC cuts. Let's try to figure out something else that we could throw on top of this to make the markets more challenging to deal with. But that's where, in my opinion, a company like Valero, who has an incredibly good management team, we can maneuver through these kind of challenges, very, very important. So with that, okay, here's my message to you guys. Did I get discouraged? The sun's going to shine again, and what you have in front of you is an incredible opportunity. We're trying to figure out how we're going to take advantage of it, and you guys should be doing the same thing. So with that, I'll go through a disclaimer that says, nothing I say really matters. But you guys have all seen this -- the safe harbor statement before, so I won't go through that. But who are we? Well, we are a large refining and renewable fuels produce -- production company. We're the largest global independent refiner, and we've got the largest renewable fuels business in North America. We have 3 reporting segments, and that's what you see here. You see our refining segment, which I'm sure most of you are familiar with; our renewable diesel segment, which we continue to invest in and it continues to grow; and then we've got our ethanol segment. And we are the second-largest ethanol producer, I believe, in the United States with about 112,000 barrels a day of production. Now here's our geographic footprint. And you can see that we are geographically diverse. The teal-colored states or blue-colored states are those that we have a marketing presence in, where you see the logo. That's where we have a branded marketing presence. And you can see we have significant refining capacity all the way from the West Coast, concentration in the U.S. Gulf Coast. We've got our Mid-Continent plants, and then we cover the Atlantic Basin out of Québec City and Pembroke. And then you can see now we've added the pipelines and the ethanol plants in there also. So we've got the markets covered pretty well. And globally, we've got the markets covered out of the Gulf Coast. Now this is our very simple strategy that we've consistently executed now going on 6 years. And it's got 3 components to it. One is being the best operator in the business. We focus on operational excellence above all else. The second thing is continuing to invest in high-return projects that allow earnings growth. And then the third is our commitment to our stockholders, and we do this through our disciplined capital allocation strategy. And these things are very easy to explain. They're just hard to execute. And what I'll show you here now over the next several slides is what we've done. This is the capital allocation framework that we put in place, I believe it was in 1984 -- or, excuse me, 2014. Yes, I said it like Joe Biden there for a second. 2000 -- sorry, Joe, 2014. But the overriding constraint here is to maintain a strong balance sheet with an investment-grade rating and a debt-to-cap that's very manageable. Then we've got our non-discretionary use of cash, which goes to sustaining CapEx and then the dividend. And those are things that we will use that strong balance sheet to defend. And then we've got competition among the remaining cash flow that we produce, among growth Capex, acquisitions and cash returns. This framework has worked for us during the really good times, where we had really high margins, and the more challenging times, where we were operating at margins that are around mid-cycle or below. So we're very confident of its ability to be applied. And we'll adjust between these components, but that framework is what guides us. Now how we've done in that allocation framework where you can see -- by the bar charts on the left, you can see what we've done with the dividend. And you'll note that, that bar has continued to increase. You can see our sustaining Capex. Those have been pretty consistent over the years. Our growth CapEx have come down some over the last 5 years. And then our buybacks. And our buybacks vary based on the free cash flow we produce. We always say that the buybacks essentially are the flywheel that we use to allocate cash under. And then if you see the pie chart there on the right, you can see the allocation between our sustaining CapEx and our growth CapEx with a target again of $2.5 billion a year. And we say that generally, $2.5 billion is a number that we're comfortable spending year in and year out, and it's essentially what we do. Now this is our commitment to cash returns to our shareholders. And you can see how we've done on the buybacks. We brought down our absolute share count in a significant way. And we've had a steady increase in the dividend over the years. The dividend yield that we're looking at here is extraordinarily high, I would say. If you had told me we'd be at a 5.5% dividend yield early in the year, I probably wouldn't have believed it. But with what we've had happen over the last week, it has created an incredible opportunity for an investor who's looking for yield because this dividend is very sustainable. So anyway, that's what we've done on that front. Operationally, safety and reliability are something that we focus on constantly. And our personnel safety stats here are something we're very proud of because we work very hard at it. And we had the best ever employee safety results in 2019. And then if you look over at our Tier 1 process safety, it continues to be excellent year in and year out. And then if you look at these stack charts down at the bottom of the page, this is how we stack up relative to the peer group. Well, it's really the 84 refineries, I think, that are out there that are evaluated by Solomon every year, and you can see how we stack up. And we're first quartile as an entire portfolio in many of these categories, which is pretty impressive when you get down to it because we have 14 or 15 refineries that are included in that group. And so the more of our refineries that are first quartile makes it more difficult for the others. So you can see we've done well. And maybe one of the key things to look at here is the consistent improvement that we've had in our personnel and our maintenance and our noncash OpEx and so on. Every year, we continue to focus on improvement here. And you can see how we've done over a 10-year cycle. It's pretty impressive. And that's a real tribute to Lane and his group. Now reliability. So those things we just looked at and the capital that we spend every year on sustaining CapEx lends it very well to having a strong and high mechanical availability. And again, this stack chart you see with the quartiles on the left, this is how we stack up in the Solomon survey. And again, that's our entire portfolio of assets. And some are better than others, but overall, they're all very solid and we've had good results. And then if you look at this bar chart on the right, you can see that this relentless focus that we have on being the low-cost operator continues to pay off, and we continue to have the lowest cash operating cost among the peer group. And obviously, in a market where you oftentimes are working very hard because the margins aren't very high, you have a situation here where being the low-cost producers is a true competitive advantage. And we're low on cash operating costs without cutting back on our capital expenditures, our maintenance CapEx. We don't short our plants on maintenance. So anyway, we're in a good place there. Now another thing that we're -- where we feel we're advantaged on -- I don't know if that's me getting chimed or -- oh, can you bring home salmon tonight? I do feel like Joe Biden. Okay. Sorry about that, you all. So anyway, advantaged crude supply. We used to have -- and you guys, probably many of you remember this chart. We used to show our crude supply in the Gulf Coast and the Mid-Continent. With the way that the markets have shifted here, we feel it's more relevant right now to show our Gulf Coast refining capacity. And you can see that Valero has the largest capacity -- throughput capacity of any other refiner in the U.S. Gulf Coast. And then if you look here on the chart on the right, you can see very clearly the ranges of feedstocks that we can run. We have tremendous flexibility within the system to adjust, and that's been so critically important with the market being the way it is and the things that I mentioned earlier: You've got very low supplies of medium sour; you got heavy sour, where the discounts haven't been there; you've got an abundant supply of light sweet crude, which is really great that we added those 2 crude topping units a couple of years ago. So we have tremendous flexibility to adjust to what the market is giving us. And we can talk more about that later, and I'm sure Lane will be answering questions on feedstock supply here in a few minutes. Okay. This goes to the point I mentioned earlier, that a strong U.S. Gulf Coast/Atlantic Basin presence allows you to move a fungible product wherever there's demand globally. And these dots that we've got on here are actually markets that we're moving barrels into. This isn't a wish list. This is where barrels are actually going. So we have focused on -- if you had a view of the world that said gasoline demand in the U.S. is going to be flat to declining because of CAFE and other efficiency standards going forward, and diesels based on economic activity, if you had that view, this is what you want to see on a chart. You want to see companies that have the ability to continue to run at high utilization rates and move their barrels into higher-netback markets. And that's what Valero has spent a lot of time and a lot of energy focusing on over the last several years. We've built the infrastructure, as you can see here on the right, to do product exports. We could export more than we do today. And you say, well, why aren't you exporting more? And I'd tell you because the R was more valuable to keep the barrels here than it was to put them into a different market. And you'll see that in some of our results, our export numbers from last year. So anyway, we have tremendous capacity to increase the exports as we are today, and then we've got a couple of projects like the Pasadena terminal and so on that would allow us to export more in the future if we chose to do that. Now I mentioned growth projects to you before. And I also showed you how much money we're spending on growth CapEx. It's about $1 billion a year on growth CapEx. And if you look at the projects that were completed in 2019, they produced about $350 million of EBITDA. And that includes those 2 -- those 3 projects that are listed there and then some other optimization projects. And then if you look at the list of projects that we currently have underway, the Pasadena terminal is a deal we're doing with Magellan that will provide us with greater access to export markets; the St. Charles alky is going to produce high-octane products that we fully expect we're going to need more of in the future; Pembroke cogen is -- we did the Wilmington cogen a couple of years ago, we're doing a Pembroke cogen now to lower our energy costs in those markets; and then the Diamond Pipeline expansion is underway. And then we've got the Diamond Green Diesel II (sic) [ Diamond Green Diesel train II ] and so on. And the Port Arthur Coker. Those are 2 major projects we've got. So we've got some really good projects that we're working on right now. And then we've got other projects that Lane and the team have under development. And a lot of that focuses on the renewable fuels business and moving barrels into Mexico and other markets that are short. And then if you look at this chart on the right, this chart illustrates the incremental EBITDA that Valero will produce based on our return thresholds and kind of a constant $1 billion a year of CapEx. And so far, we've been able to achieve these results. So we feel very good about sharing this and about our activities that we're undertaking to continue to grow earnings into the future. Now one of the projects I mentioned here was the Port Arthur Coker, and it's a big project. We're going to spend $975 million to get 55,000 barrels a day of capacity. We've talked about this many times, and Lane can be specific with you, but it's not an IMO-driven project. It was a project to make the refinery more efficient, to create 2 trains, particularly during a turnaround cycle, where we used to have to cut back the refinery materials. Now we'll be able to run it more aggressively. And what's interesting about this project is it is a high-turn, high-IRR project, but it's also a high EBITDA-producing project based on the fact that we had some of the equipment in place and it's a bolt-on project to the existing refining operations. So big project and a very good project, and it still looks really good even in today's market conditions. Okay. Renewable diesel. This has probably been one of the more talked about things that we're involved in. And as I mentioned, we're the largest renewable diesel producer in the United States. We've got -- we just finished an expansion last year, which had great results. We've got another project underway, and we're looking at a third. So the numbers that we're getting on this were good. $1.26 a gallon margin is what we were forecasting, and we've been in that range or a little higher recently. And then you throw on top of that $1 a gallon of Blenders Tax Credit, and you're at an over $2 a gallon margin on this. It's a pretty incredible business. And so you say to me, well, why aren't you doing 1 million barrels a day of that instead of gasoline? Well, there's a lot of constraints associated with it, and one of them is the feedstock supply. We've got a very low-carbon-intensity feedstock supply based on our relationship with Darling. Now we could run soybean oil and other feeds to these, but it's not going to have as low a carbon intensity as the feedstock supply that we currently have. So we're looking very carefully at the portfolio, figuring out where we can do these projects, where we, again, have some kind of feedstock supply advantage in getting it in and getting the products out, and that's what's leading us to look at Port Arthur for a third plant. So anyway, excellent investment that we've got. We run them well, and we're going to continue to do investments in this area in the future. And then our ethanol business. Let me just say we have very good plants, we have good management running these plants, but the financial results have absolutely been challenged. And that's because right now, there's an oversupply of ethanol in the U.S. And plants -- I don't know if there's a lot of plants under construction now, but there were a lot built. And so you've just got a situation where you have oversupply. And the industry was adjusting to this oversupply by exporting a lot more ethanol in the last several years than they had historically, and we're building out the infrastructure to do more of that. The Chinese tariffs certainly had an effect on that, but we think this is a temporary situation, and we'll be exporting significantly again as the year goes on. And that's what we need to make this business more profitable. So anyway, the ethanol business is part of our portfolio. We think ethanol is going to be part of the fuel mix going forward. So we don't feel bad about it, it's just not earning the type of returns right now that we'd like to see. Okay. So IMO, IMO is still a tailwind, I think, right now. We're seeing it develop. I don't know -- we talked to many of you guys for the last several years, and our view on this always was that it would be beneficial to the diesel market, but we would see more of the impacts on it on the feedstock supply, okay? Whether it be resids or whether it be heavy and medium sour discounts, we expected that through would see more of the impact. And I think that's probably been true so far. But this is one where, in our minds, clearly, the industry is still trying to adjust to. So it's too early to throw up your hands and say this isn't going to be anything. It's probably -- it was overhyped for a period there, and so I don't think it's going to be as good as the hype, and it's not going to be as bad as some might turn out. Maybe somewhere probably in the middle of that range. But anyway, we continue to be very, very well positioned to deal with this, both from a feedstock supply perspective. Diesel demand, we think, is going to strengthen. And then one of the things that we talked about, I know Lane talked about this extensively, was the fact that we might see a positive impact from IMO and gasoline. And I think we are seeing that. As you move feeds, it would typically go into a cat, into a blended fuel. So anyway, so far, we're not at all uncomfortable with what we've seen there. But we, too, would like to see it materialize and settle out in a more material way. And then the 2 bar charts here on the right just show how we're positioned to deal with this from a resid upgrading capacity and also from a conversion capacity on distillate. So we find ourselves in a pretty good place. Okay. So I gave my little prelude speech, which is kind of don't overreact. And what you're seeing here is numbers for 2016. This is not our forecast for 2020, okay? This is just how 2016 looked. And you can see where we were. And the whole point here is, in a low-margin environment, does Valero do okay? Okay? And in a high-margin environment, we all do okay. But how do we fare in a low-margin environment? Because our portfolio, as many point out, is not as diversified as some, it's leveraged more to refining. And so this shows you how we did relative to the peer group in all of these different categories in a low-margin environment. And then you can see how we did on average free cash flow in the period from 2012 to 2019. So you say, well, how do you achieve these results? Well, we've got good assets. We've got a great team operating those assets. We're disciplined about what we do. And again, we continue to focus every day on operating the business. And we face these issues head-on, and we continue to focus on operating costs and everything else that it takes to be the best refiner in the business. So hopefully, that puts your minds at ease on some of the issues we're dealing with today. And then the volatility of earnings. Again, we're not as diversified, so maybe our multiple shouldn't be as high as some. Well, this, again, shows you how we fared in that regard. Again, our earnings per share, our EBITDA and our free cash flow volatility over a 10-year period, which I think that goes back to when we had MPC and Phillips become independent players, so we thought it was relevant to show this over that time period. And you can see how we've done. We've done very, very well. And then the total shareholder return. I like where that chart was a week ago, much more than I like where it is today. But again, as I said, I think what we're dealing with today is an incredible opportunity rather than a crisis as far as it goes -- as far as Valero's stock price goes. Okay. So for all the reasons that we've talked about, we do think we're a compelling investment. You can see where we are on dividend yield, on our EBITDA, CAGR and so on. I don't need to read those to you. And we find ourselves very well positioned. And then the things that haven't changed. We are still -- we have a premier asset portfolio, and we have great operations. We're managing the risks of this business very aggressively. We do what we say we're going to do, and we're going to remain disciplined with our growth strategy and with our capital allocation. And we made a commitment that we're going to return 40% to 50% of our adjusted free cash flow, correct? That's how we call it, adjusted free cash flow? It was so much easier formerly when we did it as net income. But anyway, our adjusted free cash flow, you can count on the fact that we're going to continue to do these things. And so in a climate that we're dealing with today, where there's a lot of uncertainty and a lot of hype on issues and you've got a very challenging political environment, these are the things that I think you can hang your hat on. So with that, I'll stop. And Manav, I guess we'll turn it back over to you, huh?

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So, yes. So that's what we've seen so far. We definitely initially saw where the crude markets were impacted. That's probably about a month ago where [ A&F ] discounts fell, Latin American, Brazilian discounts fell. So we've seen it definitely in the crude markets. The product markets, we haven't entirely seen other than some of the jet demand was kind of off. You can see it in the DOE. You can see the yield on jet and on crude with jet's obviously down. But in terms of just our experience so far, it's been primarily a crude market phenomenon more than a product demand market.

[Audio Gap] talked about IMO [Audio Gap] about the fact that [Audio Gap]

Well, we talked about this. As we got into IMO, there was a conversation around how FCCs were obsolete in gasoline. We always felt that as you settled out, very-low-sulfur fuel oil would be primarily a blend of VGOs, [ atmos ] tar, VTBs, some diesel, some things, right, and so -- and that, that would have to -- then it's essentially you're cutting to meet that demand, you're having to cut or at least compete with FCC capacity and, therefore, gasoline demand. So we always felt all along it was maybe supportive of gasoline, and it's going to be through those feedstocks' connectivity to an FCC or fluid catalytic cracking unit. And that's what you're seeing. We've seen it this entire first quarter. Most of our -- a lot of -- a big chunk of our system along the Gulf Coast, our -- we had signals to have our FCCs cut. The other part that's supportive right now is you've seen a lot of unplanned downtime in the Gulf Coast with respect to FCCs. So in the product market, that's just -- and you guys see the same OPIS reports that we do, and they -- and we can see them in the market in terms of their positions on VGO. But really, so that, at some point, will recover, but this issue around VGO competing, whether it goes into very-low-sulfur fuel market or goes through an FCC is just something we're going to have. So it has been supportive -- in our mind, been supportive of the gas crack thus far.

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So we've always had the strategic view that Tier 3 would put pressure on octane because this is what it does. When you're hydrotreating cat gasoline and some of these other components, it just lowers the octane in the process. And so we took the strategic view that as long as we did both alkies when we finished last year with the Houston alky. The St. Charles alky will finish at the end of this year. And so the -- our view was it's going to be -- the octane market is going to be tight. And then one of the best ways to take advantage of that, through the oil shale -- sort of revolution of the NGLs. There's a huge arbitrage between NGL, namely, in this case, butane, and transportation fuel. And what it does is it makes the best component we have in gasoline, which is alkylate. So we've always thought that, we're well positioned for it. We still believe octane is going to be tight. We don't -- I think you really won't see this until butane is completely out of the pool, but I believe you'll see a -- you'll definitely see octane be a challenge. And we've seen alkylate go into storage, which it normally does, but there's not a big carry trade out there right now because we have a prompt. Right, gas cracker, you're still seeing people to try to put alkylate in a storage because I think everybody recognizes that out there in the future, we're going to need some octane.

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We -- yes, so we are. And we haven't ramped up our Port Arthur facility all the way yet, but we will. And that -- because -- that we agreed that's going to be a way you clear that -- the heavy sour barrels. They widened out quite a bit in the fourth quarter. They sort of leveled out here at sort of the 9 off, 10 off. I'm sure it still works for them to clear the barrels from Hardisty, they have to take that risk. But we definitely -- we're seeing our rail -- we have been ramping up our rail volumes at Port Arthur through the fourth quarter and through first quarter as well.

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So we're expanding the -- well, we are -- us and our partner, Plains, are expanding the Diamond Pipeline. That's a great project for us because we can -- but not a whole lot of additional money raised the capacity of getting -- be able to get Cushing all the way down into the -- sort of that region, the New Orleans region. So we'll benefit from that. It lowers our cost of delivering crude into Memphis. I think long term, we -- when you see, at some point, which is like 2022, I believe, some of the owners of Capline put a stipulation on putting in heavy sour crude, I think ultimately that's where we'll see a lot of the benefit. It's a couple of years from now. But in the near term, you'll -- it's another outlook for domestic shell crudes, getting them into that market. Today, you have to either go to Corpus and put it on the boat and get it over -- you get it into the Port Arthur area and either go through the Ho-Ho Line or you get -- in other words, there's transfer -- there's other ways. And so this will allow the domestic crude to end up in the New Orleans area.

[Audio Gap] access line [Audio Gap]

Well, I don't want to put my thoughts too much in what Pemex did. So everything I'm going to say is just sort of speculation. But what you saw with the formula is they had a lot of -- I would -- it wasn't volatility, it was sort of -- it was event driven, and they had exposure to 2 things by virtue of the formula. But one was obviously the -- this was Brent, [ TS ] and 3.5-way percent fuel -- well, 3.5-way percent fuel at some point is going to -- it already is, as of now, basically an illiquid thing that barely trades in the Platts windows. So I'm sure they saw, hey, we got to get off that just by virtue of their -- we're going to get into something that's not even a meaningful traded physical barrel anymore. Secondly, was Midland would have these incidents where it would be very discounted because all these pipelines were bottling it up and then it would finally clear. They would go from being way under TI to back up to sort of normally at TI level. And when they were using the K to try to get it back into the market, these events would suddenly put them out of the market one way or the other. Whether Midland's dumping or Midland's getting to where it's strength -- it was creating -- it was making their ability to market their crude a challenge and making their customers, I'm sure, a little bit antsy about that, right? So this allows them to more directly manage their OSP versus the market.

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So we've always had a little experience running resids. We do it all the time. It just depends on your configuration. Can you desalt these feedstocks? And so different refineries can do this differently. And so can you desalt them? A lot of people said -- claim that they can put them directly to their vacuum unit. Most refiners aren't in a position to do that unless they had a long experience like we have at our Corpus refinery. We have a desalter for our vacuum tower. So will people change? But most people will have to put them into their crude units as a crude substitute.

[indiscernible]

Oh, you're welcome. Oh, we're done?

Yes, 3 seconds, 2, 1...

Oh, oh.

Well, thank you.

Of course.

[indiscernible] last year... [Audio Gap]

Yes.

[Audio Gap]

Yes. I mean it's interesting. So -- I'll give you some background. I've heard that Dr. Fauci was at a business council meeting a week ago in D.C., and he got up and spoke. What we're dealing with is a kind of a strain of flu, right, with the coronavirus. It's spreading. It's gotten hyped. We were talking about it in the airplane, do you think it would have been this hyped if we weren't in an election cycle with a strong economy and somebody trying to make this an issue, right? So who knows? But based on what I see, if the treatment right now is wash your hands with soap and water, try to stay healthy, and I heard on the news a guy's treatment for -- is coronavirus was Gatorade for 3 days, and he was okay. I mean this is one of those things that, could it be serious? I guess it could. It's more the Chinese impact than anything. We're all trying to figure out, is the data we're getting out of China good and real? Is it going to last a long time? Is it going to force their economy to screech to a halt? The U.S. economy right now is strong. And as Lane mentioned, we're really not seeing any big impact on demand for our products. And the products that were -- except for jet.

Except for jet.

And the products that we're moving into Mexico, there doesn't seem to be any impact there and so on. So I wouldn't anticipate that we're going to see a recession. The question is how long does this last. And seasonally, does it phase out? And that's why, frankly, we are looking at this as an opportunity, okay? This whole market is all up. I mean personally, I'm looking at this as an opportunity. What should I be buying out there because people have gotten beaten down. And Valero is no different this week than we were 2 weeks ago. Our operation is absolutely no different. And we have the same people in place, and they're running the business, and we're making money. And so anyway, it's a -- one of these deals, it's a little bit like we had at the end of '18 when we had the IMO hype and then it just started selling off so hard. You'd love to be able to come out and say something. I'd love to come out and say to you guys, don't worry about this, it's not an issue, everything is going to be okay. And I guess that's kind of what I'm doing. But I'm not a doc, and so I can't speak to it directly. But I think it's -- my guess is this is going to be short lived, it's overhyped, sure. Might I get coronavirus? Could well happen. Is it going to kill me? Well, history, with what we've seen so far with this virus, would say no, it's not. So anyway, I hope next year, you're sitting in that same chair, and I hope I'm here to say we are right again, okay?

[indiscernible]?

Yes. Fat chance.

That's the first time I've ever heard of that.

Yes.

All right.

Honestly, Manav, I think the first thing they would you is go out and look -- it's the crazy [indiscernible], it's the guy -- he likes firearms, he hugs, he does all this stuff. I'd be dead meat before I got started, right? So you run a good conference. Thank you for doing this, and you guys for braving it. Because I'm sure a lot of people probably canceled out. It's great that you came. We're not going to win this battle by everybody hunkering down and putting their heads in the sand. So anyway, thanks. Is that it? Okay.