CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Valero Energy Corporation's (Valero; NYSE: VLO) ratings as follows:
--Issuer Default Rating (IDR) at 'BBB';
--Unsecured credit facility at 'BBB';
--Senior unsecured debt including Industrial Revenue Bonds (IRBs) at 'BBB'.
A total of $6.56 billion in debt is affected by this rating action.
The Rating Outlook is Stable.
KEY RATINGS DRIVERS
Valero's ratings are supported by the company's size, scale and asset quality as the leading North American independent refiner, with approximately 3 million barrels per day (bpd) of throughput capacity; its modest but growing leverage to discounted North American shale crudes; ample financial flexibility; good free cash flow (FCF); reasonable debt levels; solid export capability out of the Gulf; and higher distillate output following the completion of key hydrocracking projects.
Rating concerns center on the high levels of cyclicality which characterize refining; an unfavorable regulatory environment in the U.S.; and the risk of the removal of the U.S. crude export ban, which would erode the feedstock cost advantage currently associated with the industry. Exposure to volatile Renewable Identification Numbers (RINs) compliance costs is also a concern.
RECENT FINANCIAL PERFORMANCE
Valero's recent financial performance has been solid. Latest 12 months (LTM) EBITDA at March 31, 2014, was $5.96 billion while total debt fell to $6.56 billion, resulting in debt/EBITDA of just 1.1x. EBITDA interest coverage was 12.5x, while LTM FCF rose to $1.37 billion, consisting of cash flow from operations of $4.26 billion minus capex of $2.41 billion and dividends of $484 million.
The Free Cash Flow (FCF) outlook for Valero remains good, and Fitch expects the company will be significantly FCF positive over the next two years. Capex for 2014 is $3 billion but includes a relatively large (51%) component of discretionary spending. Of the company's discretionary capex, most (72%) is earmarked towards logistics expansions and light crude processing additions. VLO's FCF should also benefit from higher distillate volumes linked to recent and future planned hydrocracker expansions.
Valero's spun-off logistics MLP, Valero Energy Partners, LP (VLP), is expected to be the main beneficiary of parent investments in logistics assets, as most Valero logistics assets should eventually become drop-down candidates for VLP. Assets which could be placed into the MLP structure include railcar, rail loading, pipelines, and barge facilities. In the near term, VLP is not expected to materially impact Valero's results given its small size. However, as with any MLP, it will be important to see how fast assets are dropped down from the parent, what the impact of the drop-downs are on the parent's remaining asset profile, and what the parent does with cash received from those asset sales.
BRENT-WTI SPREAD CONTRACTS
Although Valero is less exposed to the Brent-WTI crude oil spread than other North American refiners, the discounts between bottlenecked North American crudes and globally traded waterborne grades have been an important component of Valero's profitability over the last few years. The Brent-WTI spread narrowed considerably in 2014 to $7-$8/barrel as new logistics capacity came online which helped move crude away from interior bottlenecks to the coast.
While further declines in key North American crude spreads would likely negatively impact Valero's credit metrics, Fitch does not believe they would necessarily result in a negative rating action for the company, given that the agency rates refiners on a mid-cycle basis.
Valero's liquidity was robust at the end of the first quarter, and included cash on hand, three committed credit revolvers ($3 billion unsecured revolver due 2018, C$50 million due November 2014, and $300 million revolver associated with VLP due 2018), a $1.5 billion A/R securitization facility, and separate committed LoC facilities totaling $550 million, as well as other short-term uncommitted facilities.
Valero's near-term maturities are manageable. The company repaid $200 million of 4.75% notes that matured in April 2014. As a result, pending maturities include $475 million due 2015, nothing due 2016 and $950 million due 2017. Covenant restrictions on Valero's debt are light. There are no major financial covenants on existing unsecured debt, but Valero's main revolver has a net debt/capitalization ratio requirement of 60% (actual ratio just 14% at March 31, 2014). Other covenants include change-of-control provisions, and limitations on additional secured debt.
Valero's other obligations were modest. Its asset retirement obligation at YE 2013 fell to just $31 million from $108 million the year prior, driven mainly by the spin-off of its retail business. The deficit on the funded status of Valero's Pension Benefit Obligation declined to just -$5 million at YE 2013 versus -$578 million at YE 2012. The main sources of improvement include better actual returns on plan assets, plan amendments, and actuarial gains.
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 interest rate and FX risk. There are no investment grade ratings triggers in any of its agreements.
Positive: Future developments that may lead to positive rating actions include:
--Debt reductions and a managerial commitment to lower debt levels and maintaining a higher ratings going forward;
--Fitch believes there are limited managerial incentives to move the rating higher; as a result Fitch does not anticipate the ratings are likely to move higher in the near term.
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 acquisition, capex or share buybacks;
--An extended period of negative FCF and rising leverage resulting in sustained (through the cycle) debt/EBITDA leverage above approximately 2.0x-2.5x.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria & Related Research:
--'Corporate Rating Methodology Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);
--'North American Energy Outlook and LNG' (July 16, 2014);
--'Energy Handbook--Upstream Oil & Gas' (July 16, 2014);
--'Global Impact of US Shale Oil - Rising Production Tempers World Prices' (Feb. 10, 2014);
--'Cash Flow Trends in the U.S. Energy Sector-Shareholder Activism Having an Impact' (Feb. 4, 2014);
--'Scenario Analysis: Lifting the U.S. Crude Export Ban' (Jan. 27, 2014);
--'Investor FAQs--Recent Questions on E&P, Refining, and Drilling and Services Sectors' (Aug. 12, 2013).