While 2020 has been a challenging year for those holding shares of energy-related companies, they have been underperforming the stock market long before COVID-19 caused demand for energy to decline and share prices to evaporate. In June 2018, Valero Energy Corporation (VLO) shares rose to an all-time high of $126.98. Since then, the stock made lower highs and lower lows, reaching a bottom in March 2020 when selling gripped markets across all asset classes. VLO and other energy companies lagged the stock market on the upside and led the way lower during the risk-off period. The stock that traded to almost $127 fell to a low of $31, less than one quarter the high.
Since the March low, the stock market recovered to new highs, but VLO only made it up to $77.11 in June before dropping back to $35.44 in October. On November 6, 2020, the stock closed at $38.17 and looked headed for a test of the March bottom. Valero is an energy company, but it does not take the price risk of the crude oil that it purchases or the oil products it sells. It buys and sells at market prices. Instead, VLO owns refineries, which require massive capital investment. VLO’s earnings rise and fall with the level of the processing or crack spread for refining petroleum into gasoline and distillates.
A dramatic recovery on November 9 shows the potential for VLO- Consistently beating EPS estimates and a juicy dividend
On November 6, VLO shares closed at $38.17 as the number of coronavirus cases in the US and Europe was rising, threatening the demand for energy as we witnessed earlier this year. On November 9, Pfizer’s news of an effective vaccine in trials lifted VLO shares along with many other energy-related stocks.
As the chart shows, VLO spiked higher on November 6 and rose to a high of $56 on November 16, 46.7% above the November 6 closing price. The stock was trading around the $50.80 level on Friday, November 20, a lot closer to the high than the low over the past two weeks.
2020 has been a challenging year for Valero. However, the company has consistently beat analyst EPS projections over the past four quarters.
Source: Yahoo Finance
The chart shows that In Q4 2019, VLO beat analyst earnings estimates by 51 cents when it reported $2.13 per share. Q1 is typically a weak quarter as the demand for gasoline experiences a seasonal lull. In Q1 2020, VLO beat by 49 cents with EPS of 34 cents. Q2 and Q3 were problematic as the company suffered from the pandemic and its impact on energy demand. However, VLO beat the estimates by 16 and 33 cents during the two quarters. Analysts expect VLO to lose $1.33 in Q4, but the earnings history point to another outperformance during the final quarter of this challenging year.
A survey of eighteen analysts on Yahoo Finance has an average price target of $58.56 per share, with projections ranging from $46 to $75. At $50.80 per share on November 20, VLO’s dividend of $3.92 equates to a 7.7% yield.
The winter months tend to be a bearish period for refining shares
Gasoline is the most ubiquitous oil product, and demand for the fuel that powers automobiles declines during the coldest months of the year. Drivers put fewer miles on their cars, causing gasoline demand to fall. Refineries shift production from gasoline to distillate products as the winter season approaches. Distillates, including heating oil, diesel, and jet fuels, experience less seasonality than gasoline. However, 2020 is anything but a typical year as the pandemic continues to weigh on overall demand. When it comes to the airline industry, the decline in travel has weighed on jet fuel demand, which often rises during the holiday season.
We are now at a time of the year when VLO shares historically display weakness.
The monthly chart of VLO shares shows that seasonal weakness tends to occur during the fourth and first quarters of the year. In 2020, the coronavirus trumped seasonality. Meanwhile, VLO and other refining companies are likely to move higher and lower with progress on a vaccine and the tragic toll of the virus, causing new lockdowns over the past weeks. The stock market tends to look forward, and a tool to immunize the public appears to be only months away as we head towards the end of 2020.
Crack spreads remain under pressure compared to this time last year
Seasonality tends to be a significant factor for gasoline crack spreads. The gasoline refining margin has been trending lower and remains below its level in mid-November 2019.
At just over $7 per barrel on November 20, the gasoline processing margin is significantly below its level at the same time in 2019 when it traded to a low of $10.52 per barrel. Gasoline refining margins look set to continue to decline based on the trend of lower highs and lower lows over the past months.
Meanwhile, the heating oil crack spread, which is a proxy for other distillate products, has been trending higher since late September as it rose from $6.44 to $11.60 per barrel. However, at the end of last week, the spread remained substantially below its level in mid-November 2019 when it traded to a low of $22.27 per barrel.
Levels to watch in crack spreads- The real-time indicator for refinery earnings
Crack spreads are a real-time indicator for the demand for crude oil, which is the primary ingredient in processing petroleum into oil products. They are also an excellent barometer for refining companies’ earnings as profits rise and fall with the processing margins. The levels of gasoline and distillate crack spreads as of November 20 were far below the levels at the same time in 2019. On November 20, 2019, VLO shares settled at $97.19, almost double the current level.
As the daily chart of the now active month January gasoline crack spread shows, short-term technical support is $6.39 with resistance at $8.29 per barrel. The odds favor a test of the downside, given seasonality during the winter season and the rising number of coronavirus cases.
The weekly chart of the heating oil processing spread shows support and resistance levels of $6.44 and $12.45, which could offer more insight into the earnings for refineries because of less sensitivity to seasonal factors.
Levels to watch in VLO shares- A vaccine is bullish; the winter of 2020/2021 could be the last chance to get in cheap
I believe that VLO shares offer compelling value for the futures at just over the $50 per share level.
The chart shows a gap from November 6 through November 9 between $39.90 and $44.90 that sticks out like a sore thumb. Price action tends to fill voids on charts over time.
The short-term level of technical resistance now stands at the recent November 16 $56 high. Above there, the July 29 peak of $59.76 and the June 8 high of $77.11 are technical resistance levels. A vaccine is on the horizon, but the coronavirus’s darkest days seem to be ahead over the coming weeks and perhaps months. We could see VLO shares retreat and fill the gap on the chart. The stock may even move lower if risk-off conditions return to markets. However, a light at the end of a long tunnel caused by the pandemic is bullish for VLO. Another selloff over the coming weeks and into early 2021 could be the final chance to purchase VLO at a compelling level for the future. The over 7% dividend will pay investors while they wait for capital growth. Even if the dividend were to disappear or the company reduces the level, VLO continues to offer value at the $50 per share level. Buying scale-down during any weakness could be the optimal approach to VLO.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.