Valero Energy Corp (VLO) — Q4 2015 Earnings Call Transcript

Good morning, and welcome to Valero Energy Corporation's fourth quarter 2015 earnings conference call. With me today are Joe Gorder, our Chairman, President and Chief Executive Officer; Mike Ciskowski, our Executive Vice President and CFO; Lane Riggs, our Executive Vice President of Refining Operations and Engineering; Jay Browning, our Executive Vice President and General Counsel; and several other members of Valero's senior management team. If you have not received the earnings release and would like a copy, you can find one on our website at Valero.com. Also attached to the earnings release are tables that provide additional financial information on our business segments. If you have any questions after reviewing these tables, please feel free to contact our Investor Relations team after the call. I would like to direct your attention to the forward-looking statement disclaimer contained in the press release. In summary, it says that statements in the press release and on this conference call that state the company's or management's expectations or predictions of the future are forward-looking statements intended to be covered by the Safe Harbor provisions under federal securities laws. There are many factors that could cause actual results to differ from our expectations, including those we've described in our filings with the SEC. Now I will turn the call over to Joe for a few opening remarks.

Well, thanks John, and good morning, everyone. The fourth quarter and full year 2015 were really great for Valero. We operated safely and reliably, achieving our lowest ever employee injury rate in refining and reaching an annual average refinery utilization rate of 95%. The markets were favorable during the quarter. Domestic product demand grew supported by lower pump prices and sour crude discounts relative to Brent were attractive to our highly complex refining system. While distillate margins were pressured during unseasonably warm weather in North America and Europe, distillate demand in Latin America remained robust. In fact, we exported record volumes of distillate and gasoline in the fourth quarter. We continue to execute well in our projects. In the quarter, we successfully commissioned the new Corpus Christi crude unit, the Port Arthur gas oil hydrocracker expansion and the McKee crude unit expansion. Our Quebec City refinery also began receiving crude via Enbridge’s Line 9B. We exercised our option with Plains All American to acquire a 50% interest in the Diamond crude oil pipeline project. Once completed, this project will connect Cushing with Memphis and provide us with crude optionality and long-term cost savings versus sourcing crude oil from St. James. Additionally, Valero Energy Partners continues to execute its growth strategy and Valero GP’s interest in VLP reached the high splits with the distribution increase we announced earlier this week. We also continued to advance our refining growth strategy. Construction of the Houston crude unit remains on schedule with start-up planned in the second quarter of 2016. Earlier this month, our Board of Directors approved the Houston Appalachian project. This project is estimated to cost $300 million and is expected to be completed in the first half of 2019. Finally, regarding cash returns to stockholders, we paid out 80% of our 2015 adjusted net income, exceeding the 75% annual payout target. Further demonstrating our belief in Valero’s earnings potential, last week our Board of Directors approved a 20% increase in the regular quarterly dividend to $0.60 per share or $2.40 annually. With that, John, I’ll hand it back over to you.

Okay, thank you, Joe. Moving on to the results, we reported fourth quarter 2015 adjusted net income from continuing operations of $862 million or $1.79 per share versus $952 million or $1.83 per share for the fourth quarter of 2014. Actual net income from continuing operations was $298 million or $0.62 per share, which compares to $1.2 billion or $2.22 per share in the fourth quarter of 2014. Please refer to the reconciliations of actual to adjusted amounts as shown in the financial tables that accompany our release. For 2015, we reported adjusted net income from continuing operations of $4.6 billion or $9.24 per share compared to $3.5 billion or $6.68 per share for 2014. Actual net income from continuing operations was $4 billion or $7.99 per share in 2015 versus $3.7 billion or $6.97 per share in 2014. Fourth quarter 2015 refining segments adjusted operating income of $1.5 billion was in line with the fourth quarter of 2014. Stronger gasoline and other product margins combined with higher refining throughput volumes were offset by lower distillate and petrochemical margins and lower discount for sweet crude oils relative to Brent crude oil. Refining throughput volumes averaged 2.9 million barrels per day, which was 34,000 barrels per day higher than the fourth quarter of 2014. Our refineries operated at 97% throughput capacity utilization in the fourth quarter of 2015. Refining cash operating expenses of $3.47 per barrel were $0.29 per barrel lower than the fourth quarter of 2014, largely driven by favorable property tax settlements and reserve adjustments and lower energy costs. The Ethanol segment generated $37 million of adjusted operating income in the fourth quarter of 2015 versus $154 million in the fourth quarter of 2014, due primarily to lower gross margin per gallon driven by a decline in ethanol prices versus relatively stable corn prices. For the fourth quarter of 2015, general and administrative expenses, excluding corporate depreciation were $206 million and net interest expense was $107 million. Depreciation and amortization expense was $494 million and the effective tax rate was 28% in the fourth quarter of 2015. The effective tax rate was lower than expected due primarily to a reduction in the statutory tax rate in the United Kingdom and the settlement of income tax audits in the United States. With respect to our balance sheet at quarter end, total debt was $7.4 billion and cash and temporary cash investments were $4.1 billion, of which $81 million was held by VLP. Valero's debt-to-capitalization ratio, net of $2 billion in cash, was 20%. We have $5.6 billion of available liquidity excluding cash. The cash flows in the fourth quarter included $732 million of capital investments, of which $164 million was for turnarounds and catalysts, and $136 million was for our investment in the Diamond pipeline. For 2015, capital investment included $1.4 billion for stay-in business and $1 billion for growth. We returned $1 billion in cash for our stockholders in the fourth quarter, which included $240 million in dividend payments and $767 million for the purchase of 11.1 million shares of Valero common stock. For 2015, we purchased 44.9 million shares for $2.8 billion. For 2016, we maintain our guidance of $2.6 billion for capital investments including turnarounds, catalyst, joint venture, and strategic investments. This consists of approximately $1.6 billion for stay-in business and $1 billion for growth. For modeling our first quarter operations, we expect throughput volumes to fall within the following ranges: US Gulf Coast at 1.61 million to 1.66 million barrels per day, US Mid-Continent at 430,000 to 450,000 barrels per day, US West Coast at 245,000 to 265,000 barrels per day, and North Atlantic at 465,000 to 485,000 barrels per day. We expect refining cash operating expenses in the first quarter to be approximately $3.85 per barrel. Our Ethanol segment is expected to produce a total of 3.8 million gallons per day in the first quarter. Operating expenses should average $0.37 per gallon, which includes $0.05 per gallon for non-cash costs, such as depreciation and amortization. We expect G&A expenses excluding corporate depreciation for the first quarter to be around $175 million and net interest expense should be about $110 million. Total depreciation and amortization expense should be approximately $470 million and our effective tax rate is expected to be around 32%. That concludes our opening remarks. Now before we open the call to questions, we again respectfully request the callers adhere to our protocol of limiting each turn in the Q&A to two questions. This will help us ensure that other callers have time to ask their questions which are also important. If you have more than two questions please rejoin the queue as time permits.

Guys, good morning. Just a quick question on the alkylation unit. First, can you provide any kind of return expectations that you have for the project? And then secondly on the spending profile, it looks like your CapEx guidance in 2016 is about the same as it was before. So, I’m just kind of confirming that most of the spending probably is weighted towards 2017 and 2018?

Well, hey, Blake, this is Lane. Yes, the Board approved the alkylation unit about $300 million, the estimated EBITDA is about $105 million; if you use 2015 prices it would be about $140 million EBITDA. With respect to the budget, when we look at our original guidance for this year two years ago, it’s up about $100 million and it’s mainly due to the Port Arthur turnaround. We have a little more turnaround than we had in our outlook two years ago, but certainly, and all the rest of it, the alkylation unit clearly fits inside our $100 billion a year strategic capital, it’s normally about $100 million a year and it is back-weighted like you said towards 2017 and 2018.

Okay, Lane. Secondly, just maybe if you don’t mind sharing some thoughts around light heavy spreads into 2016, especially in light of Iranian barrels coming to market that could potentially displace some other barrels globally, seems like maybe that would have an indirect benefit to Valero given your leverage to Gulf Coast in heavy processing?

Yes. Blake, this is Gary Simmons. Overall, yes, we’ve seen very good spreads between the medium sours and light and heavy sours as well. Certainly, the Iranian production coming online will put further pressure on those differentials. I think we see several things in the market, you know the increase in OPEC productions, putting medium sour barrels into the Gulf. You see Gulf of Mexico deep-water medium sour production rising at the same time we’re seeing some of the light sweet production falling off here in the United States, so it's leading to very good differentials. I think the other thing, you know, a fundamental shift is where fuel oil had been trading around 80% of Brent, it’s now trading around 60% of Brent, which should mean that we would expect to see good medium sour and heavy sour differential throughout the year. I think the other thing for us, the Iranian production, of course we won’t be running any of those barrels, but we do think the market rebalances and makes some additional heavy and medium grades available to us from Latin America.

Great, thanks for the color, Gary. I appreciate it guys.

Hey, good morning.

Good morning, Neil.

So Joe and Gary, you guys have a unique window into what’s happening from a product demand perspective; it’s one of the big debates in the oil markets right now. Can you talk about what the export markets look like from your perspective for diesel and gasoline? And then to piggyback off of that, you’ve seen four weeks now of these gasoline builds in the inventory, is that consistent with what you’re seeing on the ground?

Yes, Neil, this is Gary. I think we continue to see very good export demand for our products; as Joe mentioned, we had record volumes in the fourth quarter. We continue to see good demand for both distillate and gasoline abroad. Our rack volumes remain very strong; we’re moving a lot of products over the racks and have seen good domestic demand for our product as well. Certainly, I think when you get this early in the year it’s kind of hard to dissect the inventory data; we’ve seen large builds as well; some of the data does look a little suspect. I think we’ve seen a lot of weather issues in the Gulf that may have hindered some of the waterborne barrels from being able to leave due to fog and weather that we had in the Gulf. The Mississippi River flooding also has hindered some of the refiners along the river; their ability to clear those barrels as well. I think we’re just too early to really get a good view of what demand’s going to look like, but everything from our perspective looks good.

Yes. The fundamentals, I think for strong demand are still there. There’s no question about that. I mean we continue to have prices that are very attractive at the street and then there’s a lot of data that’s coming out recently on vehicle miles traveled being up and also on auto sales being skewed towards larger SUVs and light heavy trucks. So, again as Gary said, it seems like every January, Neil, we find ourselves in a situation where we’re looking at the year and everybody's trying to figure out, oh gee, is this over and is demand going to be totally eroded. As he said, I think it’s just a little early to tell, but fundamentally it looks like things should go well for us going forward.

I appreciate that. The second question, Joe, this is to you, is just the outlook for M&A. I think in the past you’ve said that you want to see that relative multiple between Valero and the Group move a little bit higher before you be more aggressive around M&A. So just your latest thoughts there and also at the parent level and the midstream level.

Okay, and Neil, we gave Ciskowski the responsibility for this M&A activity, which he greatly appreciated, the added responsibility. So if I give him a crack at this to start?

Yes, thanks Joe. I appreciate it. For Valero, our appetite for midstream M&A and M&A in general hasn’t changed. We continue to look at opportunities particularly those that support the earnings growth that we can achieve in our core business. The good news is we have a great portfolio and significant earnings capability as we demonstrated in 2015. More specifically to the VLP, VLP hasn’t reached the size where it can execute most of the M&A transactions on its own. But we do continue to evaluate opportunities there as well. But as we said before, we remain committed to VLP’s dropdown growth strategy, and we’re not interested in a step-up transaction that would change VLP’s risk profile or its growth story.

I appreciate that Joe and Ciskowski, thank you.

Good morning. Congrats. I think this time last year I’d said I was going to drive down an F350 to Disney World, and would that be enough gasoline yield from Valero and other refiners in the summer to make it possible for me to do so? So, I’m going to ask the same question after a year of looking at gasoline markets and some very strong cracks and strong demands. What are you guys doing to be able to make more summer grade gasoline?

In the short run, I don’t think we really have anything that we have on the horizon that’s going to be able to increase our gasoline yield, but the big thing is the alkylation project that Lane mentioned that will give us additional ability in terms of making additional gasoline when that project comes online.

We are in maximum gasoline mode now though.

Okay. And then switching to the self-help; obviously the toppers coming on stream, so we start to see them maybe in 4Q and into this year. You used to have sort of a $500 million number, I think that’s gone down to $430 million. Just a reminder what you think key drivers will be in terms of the spreads driving that $430 million?

Hi, this is Lane. So, the funding decision on both those units we had Brent and LLS price pretty much in that environment. If you want to - and we like to reference the historical price set. So if you look at those projects in 2015, the Corpus unit would give us about $200 million of EBITDA and the Houston crude unit would be about $230 million. These are also examples of quick-hitting, self-help. These were also our low-hanging fruit - we need to figure out where we can put a little capital and get a pretty good hit on it. So I don’t know if that will show up in the revenue stream or something like that to you guys, it will certainly show up in our margin capture going forward.

And it’s mainly crude against VGO spreads we should look at?

That’s right, the driver here is crude versus really resid, so low sulfur resids.

Good morning guys. Maybe a follow-up to the product demand question, given the macro uncertainty pacing your cash returns to the net income makes sense on a quarterly basis. How do you think about using the balance sheet to fund the cash returns buyback and has that changed at all given that macro uncertainty or share price volatility?

Well, our balance sheet is, Evan, this is Mike. Our balance sheet is very, very strong and we intend to keep it that way. Our guidance is to pay out 75% of net income for 2016. So, as far as leveraging up to meet that target, I'm not sure it will be required to do that. It's early in the year. So, we'll just have to see how the year plays out.

Got it. And then, maybe a different follow-up on you shared the EBITDA on all these new projects, it will be contributing in 2016 and Corpus, Port Arthur, McKee, and Houston in 1Q. I mean any color in aggregate how they affect your crude slate flexibility or just related, given the right economic indicators, where do you need to max out your heavy sour and medium sour runs?

Yes. So, the topper really just gave us more capability to run domestic light sweet barrels or foreign light sweet barrels. It really added to that. We haven't done anything that really materially changes our ability to process medium or heavy sour grades in our system. It was mainly those two units adding 160,000 barrels a day of light sweet capacity.

Right, and then, but the increase from one quarter to the next in overall heavy and medium sour runs, where could that be? And I'm sure that's an average number. So I'm just trying to get a sense of if you are at your maximum capacity right now or how much more you could take on.

I’d like to give you a little color on that, Evan. I will take the topper out so you can kind of have an apples-to-apples comparison. If you take the toppers out between last quarter and where we are today, we backed out about 400,000 barrels a day of lower 48 domestic light sweet crude and we've replaced that with medium sour grades and foreign light sweet imports. That's the big change in our system; heavy sours are about the same.

Hey, thanks, good morning gentlemen. Maybe I wanted to say, maybe a quick follow up on the prior question on potential drop to VLP, any thoughts as to what the next might look like between cash proceeds and equity, the Valero or any thoughts on evolution of multiples of those drops or too much uncertainty in the market at this point.

There is quite a bit of uncertainty in the market. So, at this point in time, I really can’t comment on how the cash proceeds would be and how the financing of those drops would be structured.

This is Gary. I think over time LLS and Brent traded pretty close to parity, but I think we are going to have a lot of volatility between the grades as the year goes on. So, you know you can see LLS got has to pay a premium for LLS and Brent, so we started importing foreign light sweets, we have the inventory gains here in the US, which I think tells you LLS was too expensive, so that LLS we discounted. I think we’ll go through that volatility for the next six months, where we swing in and out of domestic light sweet production into our refining system.

Hi, guys. Good morning.

Hi, Paul.

Okay. Yes, I feel right now a billion is our current plan toward the dropdown. But, the capital markets are pretty challenging right now. So we’ll just have to continue to monitor this as we move through the year.

Okay. Second question is just there has been some talk about the uplift we could see from greater utilization rates from these Chinese refineries and the impact that could have on product export by China. I’m just wondering how you’re speaking about this risk and do you think China’s product quality can complete on the global market especially on the gasoline side?

I can, Phil. This is Gary, I don’t know that I can really comment on the quality of their products, overall to me that capacity is capacity that’s going to be very challenged globally because of the weak fuel market. It’s going to be very difficult to run load complexity capacity with the very low fuel environment.

Hey, thanks, good morning gentlemen, maybe said I wanted to say, maybe a quick follow-up on the prior question on potential drop to VLP, I mean any thoughts as to what the next might look like between cash proceeds and equity, the Valero or any thoughts on evolution of multiples of those drops or too much uncertainty in the market at this point.

While there is quite a bit of uncertainty in the market. So, at this point in time, I really can’t comment on how the cash proceeds would be and how the financing of those drops would be structured.

Hi, good morning everyone. Thanks, Joe. I wanted to revisit your comments about gasoline. You mentioned you're currently in maximum gasoline mode. I'm curious about how gasoline yields will be affected as the US turns back to imports due to declines in light sweet crude. While there is a lot of focus on octane, I'm wondering if we might see a tightening in gasoline balance at this point. I'm trying to grasp how you see things unfolding as we approach summer. Can you share your thoughts on how these factors might interact?

Gary do you want to go ahead?

Yes. Overall, if you look at foreign light sweet barrels versus an Eagle Ford or Bakken type barrel and nasty yield from West African Saharan barrel is about the same as Bakken or Eagle Ford. So in terms of refining yield it’s not significantly different whether we are running a West African barrel or we’re running a domestic light sweet barrel.

Well as you swing back towards medium-heavy, does the yield makes changes?

Yes, for medium to heavy barrel, it would accept for most of the refineries were running those barrels are very high complex refining assets. And again we don’t see much of a yield difference with the complexity of our refineries when we’re running a heavier diet. The only thing that we can get into is as we go heavy in some of our plants it can lower our utilization. So we get a lever effect by running light sweet at some of those refineries. So we have a big incentive to run much heavier crude diet it can mean that we are running slightly lower crude rate at some of those plants.

It tells me about the old school I guess. Thanks for that. My follow-up, it’s probably more a Ciskowski question. Mike, the tax rate looks like it’s been consistently low now or becoming kind of a regular thing, so should we be looking at tax rate guidance moving lower as kind of a permanent shift?

Well, we had a couple of unique items this past quarter, because of the tax law finally being approved in the UK and then we had some audits that were underway in the US and we happened to get those settled this quarter, and so that was reflective which pushed the rate down to 28%. We try to do the best that we can and given that guidance to you. But, 31%, 32% is what I would say for the first quarter.

Is that a good run rate going forward?

Yes, right now that would.

Great, thank you.