Valero Pumped Up for the Future


Pick a major California intersection and you'll see the familiar gasoline brands: Arco, Mobil, Chevron, 76, Shell, Valero.


OK, it's still far from being a household name like the others, but Valero Energy Corp. is poised to become one of the major fuel providers in the state--as well as the largest independent oil refiner in the country.

And it's doing so quite profitably, thanks to its own strategic moves under Chief Executive William Greehey and to the surge in gasoline prices to record highs this year.

Indeed, Valero today is expected to post second-quarter earnings of $4.20 per diluted share, or nearly triple its profit of a year earlier, joining other refiners that are reaping big profit gains from the jump in prices.

What's notable is that, five years ago, this San Antonio-based concern operated just a single refinery. But it aggressively bought several more at bargain-basement prices when the refining industry was in the doldrums, and thus it was positioned to see the expansion pay off handsomely with the spike in fuel prices this year.

"Valero is simply taking advantage of a good strategic opportunity," said Trey Hamblet, assistant research director at Industrial Information Resources Inc., a Houston firm that studies industrial sectors.

Valero also spent heavily to upgrade many of those refineries to process lesser and cheaper grades of crude oil. That reduces Valero's operating costs and widens its profit margins.

"We figured we would have the advantage of using a cheaper feedstock" with which to make gasoline, diesel fuel and other refined products, Greehey said in an interview.

And Valero is in the process of sealing its biggest purchase yet: the $4-billion buyout of rival Ultramar Diamond Shamrock Corp., which would give Valero its much bigger presence in California.

After closing that deal, which was announced in May, Valero would have $32 billion in annual revenue, 23,000 employees and 13 refineries, including two in Northern California and one in Wilmington in Southern California. With the capacity to refine 1.9 million barrels of oil daily, Valero would be the biggest independent refiner in the U.S. and second overall to giant Exxon Mobil Corp.

Valero also would have more than 5,000 service stations, including about 770 in California, that pump gas under the Valero, Ultramar and Beacon brands. Those outlets include about 260 Exxon-branded stations in California that Valero supplies under a prior deal it made with Exxon Mobil.

Most of Valero's stations are in Central and Northern California. With Ultramar, Valero would have about 13.4% of the gasoline market in the San Francisco Bay Area, thus ranking fifth in that region just behind Tosco Corp.'s 76 brand, according to Burnett & Associates, a research firm in Tulsa, Okla.

"Valero has been a very shrewd buyer" of other properties "and created a lot of value for its shareholders," said Jay Wilson, oil analyst at J.P. Morgan Chase & Co. in New York.

One of Valero's Texas refineries, in Corpus Christi, is among the few elsewhere in the country capable of producing the special, low-emissions blend of gasoline required in California. That is helping Valero take advantage of the relatively high profit margins that California fuel sales afford.

But Valero and Greehey face plenty of challenges. The run-up at the pump peaked in May, and prices have since steadily declined. As a result, Wall Street analysts are expecting Valero's 2002 profit to markedly trail this year's earnings, and in response investors have pushed Valero's stock sharply lower.

To be sure, Valero's stock still trades more than double its price of five years ago, when Greehey launched the company's acquisition program. But its shares--which closed Monday on the New York Stock Exchange at $34.03, down 94 cents on the day--have tumbled 35% since hitting $52.60 on May 18, erasing more than $1 billion from Valero's total stock market value.

About 14 million shares--or a whopping 22% of Valero's total common stock outstanding--had been sold short and not yet repurchased as of mid-July by investors betting that the stock price will go even lower. (In a short sale, the investor sells borrowed stock in the hope its price declines, after which the investor can repurchase the stock at the lower price and pocket the difference.)

Analyst Andrew Fairbanks of Merrill Lynch & Co., in a recent bulletin, expressed concern that further increases in fuel supplies "and the current process of moderating refining margins from the sky-high levels of April-May could restrain [Valero's] share price, near term."

Analysts Envision High Profit Margins

This all raises the question of whether Valero is buying Ultramar at the top of the market, and whether the acquisition would look less attractive if fuel prices keep sliding.

The answer, many analysts say, is no. They emphasize that although Valero won't be able to eclipse its sterling 2001 performance during the next year or two, the company, aided by the Ultramar assets, would still be posting some of the highest profit margins in its peer group.

"Valero, and Ultramar as well, are very good operators," Wilson of J.P. Morgan Chase said.

CEO Greehey also dismissed such concerns, contending that the Ultramar service stations would give Valero a hedge against further drops in wholesale gasoline prices.

"Service stations are counter-cyclical," he said. "If you look at California today, for instance, refinery [profit] margins are going down, but the retail margins are very, very good."

But there's another looming problem: Greehey has predicted that Valero's merger with Ultramar would help keep a lid on pump prices in the state. But he also acknowledged that consumers could see prices go up instead, because of California's likely switch to ethanol as a gasoline additive to reduce smog.

The state is set to phase out its current additive, MTBE, at the end of 2002, leaving ethanol as the main alternative. But many experts say it is unclear whether there will be enough ethanol available, and whether the infrastructure for ethanol-tinged gasoline will be built in time to meet the state's deadline.

If not, there could be a gasoline shortage in California, and prices could surge again. That would be temporary good news for Valero's bottom line, if not for motorists.

"What concerns me is we're going to get blamed when prices go up," Greehey said.

And there's one other hurdle facing Valero: the question of its long-term leadership. Greehey, who is practically synonymous with Valero, is now 65. The company doesn't have a mandatory retirement age, but Greehey tried once before to retire (in 1996) before returning to lead Valero's push into refining.

Greehey said he has no plans to retire again "any time soon," and that even when he does, Valero will have a successor ready. "If I elected to retire," he said, "then someone internally would get promoted."

Whoever it is will have a tough time matching Greehey's recent record. The company started as a natural gas unit of Coastal Corp. called LoVaca Gathering Co. After Coastal shed the business in 1979, Greehey was named its chief executive, and he promptly renamed the company in honor of Mission San Antonio de Valero--better known as the Alamo.

But through the late 1990s, Valero was still a relatively small natural gas and refining company. That's when Greehey decided to expand heavily into refining, and to help pay for the effort Valero in 1997 effectively spun off its natural gas assets to PG&E; Corp. (the California utility now in bankruptcy proceedings).


Fuel for Growth

Valero Energy's performance surged in response to the company's aggressive expansion efforts and soaring profit margins in refining. Its stock rose sharply as well but lately has retreated in tandem with the drop in gasoline prices. Here are some of Valero's key financial measures:


Net income (loss) per share

'01*: $6.33


Revenue, in billions

'01*: $8.3


Stock performance (Valero shares (ticker: VLO), weekly closes and latest)

Monday: $34.03, down 94 cents


*Estimate for first six months ended June 30

Sources: Company reports, First Call/Thomson Financial



Bloomberg News

Valero's Corpus Christi, Texas, refinery is one of the few that can produce the special low-emissions gasoline needed in California.

Copyright © 2019, Los Angeles Times
EDITION: California | U.S. & World