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August 3, 2012

Valero rehabs balance sheet by dumping beer

Valero Energy's plan to cleave its convenience stores and gas stations from oil refining may allow the company to bolster its balance sheet by paying off debt and abandoning a business with narrowing profit margins.

The largest U.S. refiner by processing capacity aims to leave its retail unit with a comparable debt load to peers and keep investment-grade ratings for the remaining business. A dividend to the parent from the spinoff combined with reduced capital spending would let Valero pay off about $480 million of bonds due next year and leave the retailing business with about $750 million of debt, according to Gimme Credit LLC.

While Valero will lose the 9.3 percent of sales generated by cigarettes, beer and snacks, margins are narrowing in the retail business as those in refining grow. The spinoff may also take more debt relative to its earnings than the refinery segment, according to Madison Investment Holdings.

"You can look forward to getting some cash in from the retail spin and an improving free cash flow outlook from the perspective of a capex plan that's lower next year," said Philip Adams, an analyst at Chicago-based bond-researcher Gimme Credit. "There's cash coming in that will be dedicated toward debt reduction."

Valero's most actively traded debenture, its 6.625 percent bond due in June 2037, increased 0.73 cents on the dollar to 121.78 cents Tuesday to yield 5.07 percent, the lowest level since the San Antonio-based company issued $1.5 billion of the debt in 2007.

Chief Executive Officer Bill Klesse said Tuesday on a conference call that the company was committed to retaining its investment-grade rating, and Chief Financial Officer Mike Ciskowski said leverage at the new retail business would be comparable to peers.

Bill Day, a spokesman at Valero, which is rated two levels above junk by the three biggest ratings firms, said the company couldn't comment on specific plans for the spinoff's capital structure.

By assuming the $750 million of borrowings that Gimme Credit's Adams estimated the retail business could support, the separation would allow Valero to trim 10.7 percent of its debt while losing 9.2 percent of its earnings before interest, taxes, depreciation and amortization, according to data compiled by Bloomberg and based on Klesse's Ebitda estimate of $500 million for the retail unit.

"I don't see the retail company taking 10 percent of the debt with it; I think they're going to take more," Alan Shepard of Madison Investment, whose firm in Madison, Wisc., oversees about $16 billion of assets and owns Valero bonds, said. While "the shifting of debt off to the retail company is a credit positive for Valero," the risk that refining margins may deteriorate makes the spinoff plan credit neutral.

Valero's retailing margins have narrowed since 2009 to 3.26 percent from 3.72 percent with operating income of $381 million in 2011, Bloomberg data show. That compares with an increase to 3.22 percent from 0.44 percent for the refining business, which generated $3.5 billion last year.

New U.S. crude production in Texas and the Midwest has flooded markets and allowed refiners to buy oil for less. The crack spread, a measure of the difference between the cost of West Texas Intermediate crude and the price at which refiners can sell fuel, averaged $28.98 in the April-to-June period, almost four times the average since 1987.

Shares of refining companies such as Valero and Marathon Petroleum have gained 35 percent this year to lead every other energy sector. That compares with a 9.7 percent return for the Standard & Poor's 500 index.

Capital spending at Valero may drop as much as 44 percent next year as the company completes construction on two plants that use hydrogen to break down oil into lighter products such as gasoline, jet fuel and diesel fuels, the company said in a statement yesterday. That will boost funds that Valero can use to reward shareholders through dividends or stock buybacks, to reinvest in the company or to pay down debt.

"That is very, very helpful" for bondholders, Brian Gibbons, an analyst at CreditSights in New York, said. While it's too early to say whether the planned spinoff will improve Valero's credit quality, "it's at worst credit neutral."

The split may hurt the company's credit by removing "the most stable part of Valero's earnings and cash flows," Moody's Investors Service analysts led by Gretchen French wrote Tuesday in a report.

Operating income from the retail unit is more stable than refining, generating between $200 million and $400 million each year since 2006 while accounting for as much as 42 percent of the company's total in 2009 and as little as 3.3 percent in 2007, Bloomberg data show.

Valero's Baa2 rating from Moody's "remains supported by its large operating scale," diversity among refining operations that spreads the risk of plant shutdowns and good liquidity, the analysts wrote.

"We do not anticipate anything harsher than a negative outlook," JPMorgan Chase & Co. analysts led by Robin Levine wrote Tuesday in a research note. Valero's ratio of debt to earnings probably won't exceed 1.5 times even without paying down debt after losing the retail unit, they said.

The company's ratio of debt to Ebitda has been below 1.5 times for the past 12 months, the longest stretch since the first three months of 2009, Bloomberg data show. The gauge was 1.3 in the second quarter, the lowest since 2008.

               

With assistance from Bradley Olson in Houston.

 

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