Fortune Will Favor The Brave With Valero Energy (NYSE: VLO)

With a 30% decline in their shares from just last week, many investors of Valero Energy (NYSE: VLO) might be growing frustrated with the oil and gas giant. Their impressive 140% bounce off March’s lows is quickly being undone and the recovery rally is at risk of falling victim to the downtrend that shares have been on since 2018.

Oil stocks have also been struggling in recent months with a sluggish price per barrel and a sustained drop in demand, thanks to coronavirus, trimming any momentum they start to gather. In recent months, there have even been regular reports on record inventories as the world struggles to find space to store the unused crude oil.

Even aside from all this, as part of the overall flight from risk that equity markets experienced in Q1, energy stocks all saw substantial haircuts to their stocks. Valero dropped nearly 70% from its January levels before the bears grew tired and Wall Street saw enough value to step in. However, after recovering a decent portion of the lost territory through the start of July, shares are once again under pressure.

 Valero Energy Tied To Oil Prices

Commodity based stocks can never really get too far away from the performance of the underlying asset. As one of the world’s largest petroleum refiners, Valero’s fortune is and will continue to be reliant on strong oil prices. This was partly the reason for Morgan Stanley cutting their rating on the stock earlier this month as the risk of negative earnings revisions following a rough first half to the year increased.

But according to some, this might make them a diamond in the rough and a solid long term stock that can be picked up cheaply now. Indeed, Marco Dunand, co-founder of one of the five largest trading houses, Mercuria Energy Group, recently said in relation to oil prices that “I believe we have seen the bottom”. And to kick the week off yesterday, Jeffries joined the bulls and upgraded Valero from a Hold to a Buy rating as part of a general uptick they made to their energy watchlist.

They’re bullish about better than expected operating rates helping to raise the stock from the worst-case scenario that’s currently baked into the price. With a fresh $65 price target, that implies a 16% move in Valero shares. The company also offers a juicy 7% dividend yield which is enticing for the longer-term investors while they wait for a new bull market in oil and capital appreciation in related stocks.

Oil is a cyclical commodity and we’re certainly close if not at the trough of the current cycle with everything that’s gone on this year. Yet for all that, Valero’s internal numbers are still fairly solid. In their last earnings report, they posted a current ratio of 1.31x which means their assets outweigh their liabilities. Already this year, we’ve seen energy names declaring bankruptcy but this is not an immediate risk for Valero.

 Valero Energy Long Term Opportunity

Their reported return on assets in 2019 was 4.6% while return on capital invested was 8.7%. These are both well below their longer-term averages of 5.8% and 10.7% respectively, which, when you consider how under pressure oil has been lately, reinforces the idea that we’re near the bottom of a cycle and due a return to winning ways soon.

With their RSI flatlining at 55 for the past month, it feels like shares are undecided about their next move. Any kind of bullish news from the oil world in the coming weeks would certainly go a long way to helping them make up their mind and giving Valero the kick it needs to put in a higher-low now and push on from there. You might have to close your eyes and pinch your nose for a little bit, but over the coming months shares of Valero should come out on top.