Oil refiner Valero (click ticker for report: ) reported strong second quarter earnings. Earnings per share grew 15% for the second quarter to $1.50, which was also $0.06 higher than the Street expected. Revenue growth was also reasonably strong, growing nearly 11% year-over-year to $34.7 billion, which was $2 billion more than the consensus estimate. However, Valero’s announcement that it will split its marketing and refining businesses is what really stole the show. Nevertheless, we think shares are fairly valued at current levels.
The refining business is doing quite well sector-wide, as supported by Phillips 66’s (PSX) and Marathon Petroleum Company’s (MPC) second quarter results. Operating income in the segment grew 8% during the second quarter to $1.4 billion. The price of crude fell during the second quarter, leading to a sharp decline in operating costs, though margins are not quite as high as they were a year ago. Income in the marketing segment grew over 27% compared to the same period last year to $171 million. Management cited higher gasoline prices and higher volumes in the US as the main drivers of growth. On the other hand, ethanol profitability collapsed during the second quarter, falling 92% to just $5 million. We saw a substantial fall in profits in ADM’s (click ticker for report: ) ethanol business as well, as the industry struggles with high corn prices and weak demand.
Since the Marathon (click ticker for report: ) spinoff of Marathon Petroleum last year, oil companies have been spinning off businesses in an attempt to unlock value for shareholders. However, most firms have separated E&P (exploration and production) businesses from refinery and marketing businesses, rather than the refinery from the marketing business. Though the refinery business is relatively volatile, we like the profit stream from retail operations. Still, we do acknowledge that running each business is significantly different, so we aren’t totally surprised by the spin-off. It will also allow management to move debt onto the retail balance sheet, where it can be paid down with stable cash flow generation.
Valero trades near the lower bound of our fair value range, but shares only register a 3 on the Valuentum Buying Index, so we do not believe establishing a position in the firm is one of the best opportunities available right now. Refiners seem to be in a favorable position in the oil cycle, but we already have exposure to Phillips 66, ConocoPhillips (click ticker for report: COP) and Chevron (click ticker for report: ) in our Dividend Growth Newsletter portfolio.