Fitch Ratings has revised Valero Energy Corporation's (Valero; NYSE: VLO) Rating Outlook to Negative from Stable. In addition, Fitch has affirmed Valero's debt ratings as follows:
--Issuer Default Rating (IDR) at 'BBB';
--Unsecured credit facility at 'BBB';
--Senior unsecured debt at 'BBB';
--Premcor Refining Group unsecured notes at 'BBB'.
The revised Outlook stems from Valero's weak year-to-date financial performance, and the lack of signs of a turnaround in downstream fundamentals (margins, volumes, and utilization) heading into 2010, which may keep Valero's credit metrics weak for an extended period. U.S. unemployment--a key variable driving North American gasoline demand--remains elevated well above levels seen during the last downturn at 10%. High unemployment and the prospect of a 'jobless recovery' in the U.S. threaten to keep industry fundamentals weak for an extended period. As a result, Fitch anticipates that Valero's credit metrics may bottom out at levels worse than those seen during the last industry downturn (2002), and could remain depressed for an extended period.
Event risk is also a concern, given Valero's track record of buying refineries on the cheap during cyclical downturns (UDS in 2001) Fitch anticipates that the current deep recession may pry choice refineries loose in a once-in-a-cycle turn. The growing U.S. renewable fuels mandate (36 billion gallons per year [gpy] of biofuels by 2022) also creates incentives for M&A activity, as conventional refiners seek to reposition their portfolios to be more renewables-friendly. Valero has made several renewables investments to date including VeraSun's Midwestern ethanol plants ($566 million including working capital), as well as smaller renewables joint ventures (JVs). If a strict version of greenhouse gas (GHG) regulation is implemented, investments to lower emissions footprints may increase, heightening event and cash flow risks. For more on this topic, see the special report 'Turning up the Heat: Implications of Greenhouse Gas Legislation on Energy and Related Sectors', dated Nov. 3, 2009. At the same time, with refinery values deeply depressed, asset sales as a source of funding for such purchases seems less likely. The low multiple paid for Sunoco's 85,000 barrels per day (bpd) Tulsa refinery and the announcement of multiple closures in the industry including Sunoco's 150,000 bpd Eagle Point refinery and Valero's 210,000 bpd Delaware City refinery underscore this view.
For the latest 12 months (LTM) ending Sept. 30, 2009, Valero generated EBITDA of $2.6 billion, and free cash flow (FCF) of negative $2.05 billion. Debt/EBITDA was 2.8x, FFO/interest coverage was 5.8x, and total debt was $7.38 billion. Fitch anticipates that Valero will be significantly FCF negative in 2009 and 2010.
Valero's current financial flexibility is good, with cash and equivalents of $1.61 billion at Sept. 30, 2009 (excluding restricted cash balances of $114 million linked to a tax dispute in Aruba) and a net-debt-to-capitalization ratio of 26.6% versus covenant limits of 60%. There were no borrowings across the company's existing revolvers, including its main $2.4 billion revolver and $C 115 million revolver (both due 2012), but LCs of $132 million were outstanding on these facilities. Valero also had $900 million available on its existing $1 billion A/R securitization facility. Valero's near-term maturities are manageable, and include $33 million due 2010, $418 million due 2011, and $759 million in 2012. Total cash balances of $1.61 billion at Sept. 30, 2009 were up from $940 million at year-end 2008; however, this includes approximately $1.8 billion in capital markets financing activity. Valero's pension funding shortfall at year-end 2008 was $487 million.
Given their need to finance large working capital requirements, refiners have strong incentives to defend their credit ratings. Similar to other refiners, Valero has responded vigorously to maintain its creditworthiness in the current downturn through capex cuts, workforce reductions, slashed distributions to shareholders, capital raises, as well as the shutdown of selective refining capacity. Following these moves, however, there may be relatively little left to cut going forward. The recent permanent shutdown of the Delaware City refinery will reduce capex by approximately $200 million through 2010. While additional shutdowns/idlings will further lower reduce Valero's operating costs, Fitch also anticipates it will result in higher debt/barrel of refining capacity metrics, as Fitch would not anticipate a proportional amount of debt being retired following further plant shutdowns, all else equal.
Valero's ratings are supported by the size, scale, and the geographic diversity of its refineries, its leverage to heavy and sour crude oil economics and reasonable financial leverage. Valero's refining capacity contains several large, deep conversion refineries which are cost advantaged on a long-term basis due to their size and feedstock flexibility. Under current market conditions, light-heavy and sweet-sour spreads have seen significant compression, resulting in less favorable deep conversion economics given the higher processing costs of running coker units. Year-to-date (YTD), the WTI-Maya spread averaged only $5.19/barrel versus last year's $15.64/barrel. Sweet-sour spreads were similarly depressed. Spreads are not expected to decompress until oil demand returns and OPEC producers undo some of their quota cuts. Valero markets gasoline through approximately 5,800 retail outlets throughout North America and Aruba. Beginning with the acquisition of Basis Petroleum from Salomon Inc. in May 1997, management has grown Valero into what has become the dominant independent refiner in the U.S. The company acquired rivals Ultramar Diamond Shamrock (UDS) in 2001 and Premcor in 2005.
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