Valero Energy Hits the Jackpot

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The refining industry is booming. Companies operating in this space are generally the first ones to get hit if something goes wrong with the dynamics of the oil industry. However, Valero Energy (NYS: VLO) has turned the tables with incredible third-quarter results.

Fantastic numbers
The San Antonio-based independent refiner booked profits of $1.2 billion, or $2.11 per share, from continuing operations, a whopping 297% increase from the third quarter last year. Here's a company that combined favorable market conditions with 18% growth in refining throughput volumes.

Fantastic operations
Following an impressive first quarter, I'd mentioned that international demand for fuel is only on the rise. Valero caught onto this trend pretty early and is now reaping gains. Its acquisition of Chevron's (NYS: CVX) Pembroke refinery signaled its intentions to get directly into the international markets. This, along with a restart of its Aruba refinery operations, has seen 389,000 barrels being added per day in refining volumes. Historically, the refining segment has seen low margins. Valero seems to turn that fact on its head. It did so by increasing volumes.

Nevertheless, favorable pricing did see a 63% growth in throughput margins (i.e. revenues per barrel of refined oil) that translated into an operating income of $8.16 per barrel, up from $2.92 last year. But what really caught my attention is the drop in operating costs to $5.08 from $5.21 per barrel. Keep in mind, operating costs in this industry aren't really attractive to begin with.

A refinery that is idling, or isn't operating at full capacity, doesn't do any good for the company. The plant and machinery will still incur maintenance and idling costs, which hurts profit margins. Valero still has some way to go before it hits full throughput capacity of 3 million barrels per day from the current output of 2.3 million barrels a day. But I'm not unduly worried. I feel it's only a matter of time before output reaches full capacity. Here's why.

The company has substantially increased its capacity to process crude oil from the Eagle Ford shale play to 46,000 barrels a day. This is a huge increase of more than 40,000 barrels a day from last year. I expect this volume to further grow as this shale play matures. Production from the Gulf of Mexico is also bound to increase, which should feed the Gulf coast refineries. Additionally, with the advent of another hot play in the form of the Utica shale play, things look downright exciting for the future.

An exciting future
Sitting pretty on cash balances of $3 billion, Valero has the opportunity to go for further acquisitions and expansions as voiced by CEO Bill Klesse. The company already acquired the Meraux refinery from Murphy Oil (NYS: MUR) in October.

While this doesn't sound too surprising, Valero itself looks more like an acquisition target. While talk of a takeover by India's Reliance Industries turned out to be just a rumor, those integrated companies that want ready access to the lucrative refining sector in the U.S. might be interested. Analysts consider Valero to be cheap on every metric one looks at. Chesapeake (NYS: CHK) , which plans to increase liquids production substantially in the next 10 years, seems to fit that bill. I wouldn't want to speculate further, but Valero by far looks cheap compared to its peers.

Foolish takeaway
Whether or not it's an acquisition target, Fools should see merit in Valero's stock. For one of the biggest refiners in the U.S., the recognition it has received so far isn't exactly justifiable. The Motley Fool can help you keep track of the latest news and analysis on this stock. All you need to do is add it to your watchlist. It's free.

At the time this article was published Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article.Motley Fool newsletter serviceshave recommended buying shares of Chesapeake Energy and Chevron. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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