Valero's Spin on Retail

Refining, wholesale separation will leave "Twinkies, beer and cigarettes" to retail group

Greg Lindenberg, Editor, CSP

William Klesse

SAN ANTONIO -- In announcing that its board has authorized Valero Energy Corp. management to pursue a separation of Valero's retail business from the remainder of Valero, chairman, CEO and president William Klesse said, "After careful consideration, we believe a separation of our retail business from the remainder of Valero by way of a tax-efficient distribution will create operational flexibility within the businesses and unlock value for our shareholders. As independent companies, both retail and the remaining business will be better-positioned to focus on their industry-specific strategies."

In other words, "We're not going to be selling Twinkies and beer and cigarettes. We're going to leave that to the retail group," he said during a conference call Tuesday to discuss second-quarter 2012 results and the separation announcement.

"We will still run a branded, wholesale business," he added. "So if you think of Valero then after the spin of our retail company or separation, whatever transpires, Valero's really going be a refining and wholesale marketing company with some petrochemical feedstock production, ethanol production, power generation, hydrogen and associated logistics, so we're just a manufacturing company with a wholesale marketing business. So we're still vertically integrated."

The company is currently reviewing several potential separation transactions, including a tax-efficient distribution of the retail business to Valero shareholders.

Michael S. Ciskowski, CFO, said during the call that the spinoff could occur "in around six months."

But Valero spokesperson Bill Day told The San Antonio Express-News, "That doesn't mean we're ruling out a sale," Day said. "We're looking at the options that would be best for shareholders."

The company reported net income from continuing operations of $831 million, or $1.50 per share, for the quarter, compared to net income from continuing operations of $745 million, or $1.30 per share, for second-quarter 2011.

"Our retail business had a great second quarter and reported its highest ever quarterly operating income of $172 million, consisting of $134 million in the U.S. and $38 million in Canada. Our retail business continued to perform exceptionally well," Ciskowski said concerning the segment's performance.

Click here for the full Valero second-quarter 2012 earnings release.

Spinning off the retail business is the latest step in Klesse's effort to raise shareholder value, which has included boosting the company's dividend and promising to buy back stock, Fadel Gheit, a New York City-based analyst at Oppenheimer & Co., told Bloomberg. "Valero is the largest refiner in the U.S. and is by far the most undervalued," said Gheit. "He is frustrated."

Valero's retail segment, which includes more than 1,000 company-owned and branded gasoline and diesel stations in the United States and Canada, may be worth $2 billion to $2.8 billion, Cory Garcia, a Houston-based analyst with Raymond James & Associates Inc., told the news agency.

One industry expert told Law360 it could be as much as $4 billion.

Retail stores trade at five to seven times earnings before interest, taxes, depreciation and amortization compared with refiners, which trade at a multiple of 3.5, Garcia said. Valero's retail operating income has been above $400 million, he said.

"This aligns perfectly with what investors want to see from Valero right now, which is return of capital and liquidity events. That's why it is being met with a positive response," Dahlman Rose & Co analyst Sam Margolin told Reuters.

San Antonio-based Valero, through its subsidiaries, is an international manufacturer and marketer of transportation fuels, other petrochemical products and power. Valero subsidiaries employ approximately 22,000 people, and assets include 16 petroleum refineries with a combined throughput capacity of approximately three million barrels per day, 10 ethanol plants with a combined production capacity of 1.2 billion gallons per year and a 50-megawatt wind farm. Approximately 6,800 retail and branded wholesale outlets carry the Valero, Diamond Shamrock, Shamrock and Beacon brands in the United States and the Caribbean; Ultramar in Canada; and Texaco in the United Kingdom and Ireland.