Fitch Ratings expects to rate Valero Energy Corporation's (NYSE: VLO)
pending issuance of senior unsecured notes 'BBB'. Net proceeds from the
issuance will be used for general corporate purposes, including the
redemption of $750 million 6.125% 2017 notes and $200 million 7.2% 2017
notes.
Fitch currently rates Valero as follows:
--Issuer Default Rating (IDR) 'BBB';
--Unsecured credit facility 'BBB';
--Senior unsecured debt including industrial revenue bonds (IRBs) 'BBB'.
RATINGS RATIONALE
Valero's ratings reflect the company's size, diversification, and asset
quality; advantaged cost position including access to discounted North
American crudes and inexpensive power and shale gas; low mandatory capex
requirements and strong free cash flow (FCF); good liquidity; and track
record of defending the rating through dividend cuts and equity issuance.
These strengths are balanced by the historical volatility of the
refining sector, which is prone to boom and bust periods; currently high
refined product inventories in the U.S.; the removal of the crude export
ban; unfavorable U.S. regulations that will cap domestic refined product
demand; and exposure to volatile Renewable Identification Numbers (RINs)
compliance costs. Distributions to shareholders have also been rising
but Fitch expects these will not be debt-funded.
KEY RATING DRIVERS
SIZE, DIVERSIFICATION, AND ASSET QUALITY
Valero is the world's largest independent refiner with 15 refineries and
approximately 3 million barrels per day (bpd) of throughput capacity.
Outside of North America, the company owns the Pembroke refinery in
Wales, UK, and the Montreal refinery in Quebec. Valero also retains
significant leverage to heavy sour crude processing economics through
its deep conversion refineries in the Gulf. Valero is one of North
America's largest renewable fuel producers (11 ethanol plants totalling
1.4 billion gallons per year [gpy] of capacity, plus biodiesel
production), and holds the 2% General Partner (GP) interest and a
majority of Limited Partner units in Valero Energy Partners, its
affiliated logistics MLP.
DISCOUNTS NARROW BUT ASSET QUALITY HOLDS UP
Key crude oil spreads have narrowed sharply due to the collapse in oil
prices and repeal of the crude export ban. Brent-WTI is currently
trading close to parity, versus levels as high as $20 in 2011-2012,
removing a source of windfall profits for the industry.
While Valero has substantial flexibility to access these crudes (it can
take up to 50% light sweet crude slate following recent investments in
rail and topping capacity), it is less reliant on crude spreads for cash
generation than other refiners. A key strength of VLO's diversified
refining portfolio is its deep conversion coking capacity on the Gulf
coast which is now in the money. VLO's coking units are economic when
the discount between light sweet and heavy sour crudes increases. In the
first half 2016, Maya's discount to Brent averaged 23%, implying strong
coking economics. Increased availability of medium and heavy sour crudes
in the Gulf may cause this to persist.
CAPEX AND FINANCIAL FLEXIBILITY
Valero's financial flexibility remains strong over our forecast period.
Capex for 2016 is approximately $2.6 billion but the company's run-rate
'must-spend' capex (regulatory, environmental plus turnarounds) is in
the $1.5 billion-$1.6 billion range. Discretionary spending is split
between logistics and asset optimization (hydrocracker expansion, crude
topping units, alkylation units).
RECENT FINANCIAL PERFORMANCE
Valero's recent financial performance has been solid. Latest 12 months
(LTM) EBITDA at June 30, 2016, was approximately $6.9 billion, versus
$8.3 billion in 2015. Fitch expects EBITDA is likely to weaken further
from 2015 highs as the lingering impact of the warm El Nino winter
pressure margins, particularly for distillates. Despite this, Valero's
outlook is reasonably good and Fitch expects the company will be
significantly FCF positive in 2016.
At June 30, 2016 (prior to the proposed issuance), VLO's consolidated
debt stood at approximately $7.5 billion. This figure includes $314.1
million of VLP debt that is consolidated on VLO's balance sheet but is
non-recourse to VLO and has no cross defaults with parent debt. VLO's
consolidated debt/EBITDA was 1.1x, EBITDA/interest coverage was 16.2x,
and funds from operations (FFO)/interest coverage was 13x. The company's
LTM FCF was approximately $1.8 billion, comprising cash flow from
operations of approximately $4.8 billion minus capex of $2.0 billion and
dividends of $1.0 billion. These results included an unfavorable working
capital swing of -$367 million linked to volatility in crude oil and
other input prices.
It is important to note that VLO's consolidated metrics include VLP's
results - including its debt - because of Valero's ownership of the
controlling GP stake. However, when determining Valero's credit quality,
Fitch expects to look primarily at VLO deconsolidated (standalone)
metrics. Under our base case assumptions, VLO's deconsolidated leverage
is expected to remain below 2x over the forecast period, consistent with
an investment-grade rating for a refiner of this size and scale.
HIGHER SHAREHOLDER DISTRIBUTIONS
VLO has ramped up its shareholder-friendly activity over the last few
years. The company currently targets 75% of its adjusted net income for
shareholder distributions (dividends + buybacks). Dividends were a
modest portion of net income at year-end (YE) 2015 (21%), with buybacks
making up the remainder (approximately $2.8 billion). We expect the
company will reduce buybacks significantly in the current year in line
with lower crack spreads. It is also worth noting that in past
downturns, Valero has cut its dividend to protect financial flexibility
(including a 75% cut in 2009 and the issuance of stock). We expect the
dividend policy could be revisited if a serious downturn were to take
place.
VLP PROVIDES FUNDING OPTION
Fitch expects Valero's spun-off logistics MLP, Valero Energy Partners,
LP (VLP), to provide a meaningful source of future liquidity to parent
VLO through asset drop-downs, as well as a fast-growing stream of
distributions up to its parent.
At June 30, 2016, Valero held 66.1% of VLP's common units as well as the
2% GP stake in VLP (which includes IDRs). A significant portion of VLO's
discretionary capex of the past few years was spent on logistics
investments that can potentially be dropped into an MLP structure. VLO
currently has $1 billion in rateable EBITDA that may be dropped down to
VLP at a tax-advantaged multiple, including pipelines, racks, terminals
& storage, railcar, marine, and wholesale fuel marketing. Given recent
transaction multiples of 8x-13x for logistics drop-downs, this could
entail several billion in possible proceeds for the parent. However, as
stated earlier, this is likely to be spread out over multiple years
given VLP's small size and limited current capacity to absorb large
transactions. At the end of August, Valero dropped down its Meraux and
Three Rivers Terminal Services Businesses to VLP for total consideration
of approximately $325 million.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
--WTI oil prices of $45/bbl in 2017, $55/bbl in 2018, and $65 in 2019;
--Crack spreads that revert to inflation-adjusted historical averages
over the forecast period;
--2016 capex of $2.6 billion, stepping down to approximately $2.2
billion in 2018;
--VLO dividend growth of 10% starting in 2017;
--50/50 debt-equity funding of drop-downs and expansion projects at VLP.
RATING SENSITIVITIES
Positive: Future developments that may lead to positive rating actions
include:
--Greater earnings diversification/evidence of lower cash flow
volatility; and sustained debt/EBITDA leverage at or below approximately
1x on a deconsolidated basis.
Negative: Future developments that may lead to negative rating action
include:
--A change in philosophy on use of the balance sheet, which could
include debt-funded acquisitions or share buybacks;
--Sustained debt/EBITDA leverage above approximately 2.3x on a
deconsolidated basis.
LIQUIDITY
Valero's liquidity was robust at the end of the second quarter of 2016
(2Q16), and included cash on hand of approximately $4.9 billion, three
committed credit revolvers: a $3 billion unsecured revolver due November
2020 (approximately $2.9 billion available); a $750 million VLP revolver
due December 2020 ($436 million available); a C$50 million revolver due
November 2016 ($40 million available); a $1.3 billion A/R securitization
facility due July 2017 ($1.1 billion available); as well as separate
letter of credit (LoC) facilities. Excluding the VLP and LoC facilities,
Valero's core liquidity at June 30, 2016 totalled approximately $9
billion.
Valero's near-term maturities are manageable. Pending maturities include
$950 million due 2017, and nothing due 2018. Covenant restrictions on
Valero's debt are light. There are no major financial covenants on
existing unsecured debt, but Valero's main revolver had a consolidated
net debt/capitalization ratio requirement of 60%. Other covenants
include restrictions on secured debt (maximum of 15% of consolidated net
tangible assets), limitations on mergers, a change in control clause,
and a material adverse effect (MAE) clause. The change in control clause
is triggered by ownership or more than 25% of voting power of the
company. The revolver also allows for issuance of LoCs of up to $2
billion. None of VLO's debt or financing agreements contain rating
triggers.
OTHER LIABILITIES
Valero's other obligations were modest. At YE 2015, its asset retirement
obligation was $64 million versus $71 million in 2014. Long-term
environmental liabilities declined to $231 million at YE 2015 versus
$269 million the year prior. The deficit on the funded status of
Valero's Pension Benefit Obligation (FV Pension Assets - PBO) decreased
to $418 million in 2015 from $472 million at YE 2014. The main drivers
included actuarial gains, and higher contributions from Valero. This
shortfall is not material as a percentage of underlying cash flows.
Valero's hedging program is limited and aimed at hedging physical
commodity transactions (e.g. delays between crude loading and refined
product sales, ethanol corn purchases), although it also has a small
trading operation. In addition, Valero uses derivatives to manage FX
risk. There are no investment-grade ratings triggers in any of its
agreements.
Summary of Financial Statement Adjustments
Deconsolidated Leverage Forecast: In calculating forecasted
deconsolidated debt/EBITDA, Fitch deducts VLP debt from total
consolidated debt. To estimate deconsolidated VLO EBITDA, Fitch deducts
VLP EBITDA and adds distributions from VLP to VLO.
Date of Relevant Rating Committee: July 18, 2016
Additional information is available on www.fitchratings.com.
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/site/re/869362
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1011343
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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