CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB' rating to Valero Energy Corporation's (Valero; NYSE: VLO) senior unsecured notes issuance. Valero's Rating Outlook remains Stable. Proceeds from the issuance will be used for general corporate purposes.
A complete list of ratings follows at the end of this release.
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 although low, could disrupt 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. As calculated by Fitch, latest 12 months (LTM) EBITDA rose to $7.59 billion from $5.68 billion at YE 2013, while total debt fell to $6.39 billion from $6.56 billion over the same period, resulting in debt/EBITDA of just 0.84x. EBITDA interest coverage was 16.3x, while LTM FCF was $873 million, consisting of cash flow from operations of $4.24 billion minus capex of $2.8 billion and dividends of $566 million. Note the LTM figure also includes a large unfavorable reversal of working capital of -$1.37 billion. On a PF basis following today's issuance, Fitch expects the company's metrics will remain well within limits for the current 'BBB' rating.
The FCF outlook for Valero remains good, and Fitch expects the company will be significantly FCF positive over the next two years. Capex figures continue to include a relatively large component of discretionary spending. Of the company's discretionary capex, most 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 master limited partnership (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 WIDENS
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. Although the Brent-WTI spread narrowed considerably as crude collapsed in the fourth quarter (4Q'14), it has since widened out again as inventories at Cushing, OK have grown, most recently rising to the $10/bbl range.
Valero's liquidity was robust at the end of 4Q'14, and included cash on hand of $3.69 billion, three committed credit revolvers ($3 billion unsecured revolver due 2018, C$50 million due November 2015, 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. Total liquidity across all facilities at Dec. 31, 2014 was approximately $8.38 billion.
Valero's near-term maturities are manageable, and 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 12% at YE 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 2014 rose to $91 million from $31 million the year prior, driven mainly by additional accruals. The deficit on the funded status of Valero's Pension Benefit Obligation increased to -$472 million at YE 2014 versus -$5 million the year before. The main sources of decline included actuarial losses, and lower actual returns on plan assets.
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.
--2015 capex of approximately $2.8 billion, including turnaround expenses;
--Flat throughput volumes in 2015 and 2016;
--Crack spreads that mean revert to inflation adjusted historical averages over the life of the forecast.
Positive: Future developments that may lead to positive rating actions include:
--Debt reductions and a managerial commitment to lower debt levels and maintaining 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 2x-2.5x.
Fitch currently rates Valero as follows:
--Issuer Default Rating (IDR) 'BBB';
--Unsecured credit facility 'BBB';
--Senior unsecured debt including Industrial Revenue Bonds (IRBs) 'BBB'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria & Related Research:
--'E&P Borrowing Base Redeterminations--History Suggests Lenders May Go Easy in a Downturn' (Dec. 05, 2014);
--'Shale and North American Energy (European Investor Tour)' (Oct. 23, 2014);
--'Full Cycle Costs for North American E&P' (July 30, 2014);
--'North American Energy Outlook and LNG' (July 16, 2014);
--'North American Exploration and Production Handbook' (July 16, 2014);
--'Corporate Rating Methodology Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 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).
Applicable Criteria and Related Research:
E&P Borrowing Base Redeterminations (History Suggests Lenders May Go Easy in a Downturn)
Shale and North American Energy (European Investor Tour)
Full Cycle Costs for North America E&P (Production Costs Moderate in 2013)
North American Energy Outlook and LNG
North American Exploration and Production Handbook
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage