Thursday, March 8, 2012

U.S. Refiners and the Transformation of Manufacturing

I went to go hear management of Valero Energy yesterday.

Valero is the largest oil refiner in North America, with a market cap of roughly $13 billion.  Bill Klesse has been CEO of Valero for many years, and his remarks yesterday were both surprising and very informative.

First, some background:

Valero (ticker: VLO) was a Wall Street darling for the first part of the last decade.

In one five year stretch - from February 2002 to February 2007 - Valero's stock soared by +437% (the S&P rose by just +27% in the same time period). Mr. Klesse and his team were widely heralded  in the financial press for their management acumen.

Heady stuff indeed for a company involved in such a mature business as oil refining.

Then the recession hit.

Valero - which had previously been hailed as a model of how smart managements should run companies - was caught with too much debt and too much capacity.  Earnings plummeted, and the dividend slashed to nothing.  The stock fell from nearly $80 a share in mid-2007 to $18 by the fall of 2008.

Chastened, Valero did the hard work of cutting everything to survive.  This work - combined with an improving economy - has left the company in probably the best shape it has been in 10 years. The dividend has been restored to its prior level, and "free cash flow" has become a mantra at Valero.

Still, Wall Street is skeptical, as evidenced by the fact that Valero still trades at only 7x earnings and sports a 2.5% dividend yield.  At the yesterday's meeting yesterday only four investment people were in attendance for a management that would have drawn a crowd only five years ago.

But here's what they missed:

The United States is now a net exporter of petroleum products for the first time in decades.  Valero and other refiners operating on the Gulf of Mexico are probably the best positioned refiners in the world today. 

Low natural gas prices allow US refiners to produce products at the lowest cost of any other operator in the world outside of Saudi Arabia. Ample supplies of oil from Canada, Mexico and South America make US refiners less vulnerable to Middle East suppliers.

Political turmoil in countries like Mexico and Venezuela has severely impacted oil operations in those countries.  The hapless Chavez government in Venezuela has so starved the capital for oil industry in that country that oil exports have essentially disappeared.

Numerous small, inefficient European refiners are being shut at a time when demand for diesel is rising sharply across Europe.  They can't compete with companies in America and the Middle East.

And no one in the U.S. is talking about adding new refining capacity.  

So I'm taking a close look at Valero to see if it makes investment sense.

Problem is, Mr. Klesse and his management team have been having meetings with other investors on the East Coast.  These folks have heard what I did, and the stock is up nearly +11% in the last two days.

One final point:  Mr. Klesse thinks that the discoveries of vast quantities of shale oil and natural gas is the biggest change in his industry in nearly 40 years.

I would add one other idea:  The U.S. has suddenly become one of the most attractive places in the world to open new manufacturing facilities.

Besides cheap energy, America offers businesses low tax rates, a strong legal system, and wages that are now competitive with those in many parts of the emerging markets.  States are competing with one another to offer tax incentives for manufacturers to open plants in their states.

Could a new dawn be rising for U.S. manufacturing?