Valero Earnings: Continuation of Strong Results Supports Higher Payouts; Shares Fully Valued

Valero Energy VLO reported third-quarter earnings that slightly exceeded market expectations on a combination of continued favorable refining market conditions and strong operations. Adjusted earnings fell modestly to $2.6 billion during the third quarter from $2.9 billion the year before. During the quarter, Valero paid out 68% of adjusted cash flow in dividends and $1.8 billion in repurchases, well above its 40%-50% annual target. We plan to update our model with the latest market conditions and fourth-quarter guidance but do not expect a material revision to our fair value estimate.

Refining segment adjusted operating income fell to $3.4 billion from $3.8 billion the year before, on lower refining margins, which more than offset lower costs. Although well below 2022 record levels, refining margins remain well above historical midcycle levels, as continued strong distillate margins are compensating for very weak gasoline margins. However, much of the gasoline margin weakness is attributable to seasonal factors and recently reported demand weakness, but management remains confident the market will tighten and margins rise next year before the summer driving season. Meanwhile, the outlook for distillate remains favorable with low inventories, which could be exacerbated in the event of a cold winter, unlike last year. So, overall, the refining market remains strong. However, we see this favorable outlook as largely priced into shares already, leaving little margin of safety in the event gasoline demand weakness portends greater economic weakness.