Fitch Affirms Valero's Ratings at 'BBB'; Outlook Stable

CHICAGO--()--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 $7.42 billion in debt is affected by this rating action.

The Rating Outlook is Stable.

Valero's ratings reflect the company's size, scale and diversification, advantaged cost position that reflects growing access to discounted North American crudes and cheap shale gas, low mandatory capex requirements and strong free cash flow, higher distillate output following the completion of hydrocracking projects, strong liquidity, and a track record of defending the rating through dividend cuts and equity issuance.

These strengths are balanced by the historical volatility of the refining sector, which is prone to boom and bust periods, unfavorable U.S. regulations that limit demand for refined product domestically, the tail risk of the removal of the U.S. crude export ban, which would erode the strong feedstock cost advantages currently associated with U.S. refiners, and exposure to volatile Renewable Identification Numbers (RINs) compliance costs. Distributions to shareholders have also been rising rapidly but Fitch expects these will continue to be funded out of Free Cash Flow (FCF).

KEY RATING DRIVERS

SIZE AND DIVERSIFICATION

Valero is the world's largest independent refiner with 15 refineries and approximately 2.94 million barrels per day (bpd) of throughput capacity. Outside of North America the company owns the Pembroke refinery in the Wales, UK, and the Montreal refinery in Quebec. Valero also retains significant leverage to heavy sour crude processing economics through its deep conversion refineries in the Gulf. Valero is one of North America's largest renewable fuel producers (11 ethanol plants totalling 1.3 bn gpy of capacity, plus biodiesel production), and holds the General Partner and a majority of Limited Partner units in Valero Energy Partners, its affiliated logistics MLP.

ACCESS TO DISCOUNTED SHALE CRUDES

Valero has growing flexibility to access discounted shale and Canadian crudes across its system, which has been a key driver of the high profitability seen at the company over the last few years. New investments in rail and light crude processing are set to further expand VLO's access, including 160,000 bpd of topping unit capacity being built at its Houston and Corpus Christi refineries. Following these investments, approximately 50% of VLO's crude distillation capacity will be capable of processing light sweet shale crudes.

STRONG FCF

FCF outlook for Valero remains good, and Fitch expects the company will be significantly FCF positive over the next two years. Capex for 2015 is approximately $2.8 billion but includes a relatively large component of discretionary spending (48%), which can be quickly turned off in a downturn. Most of this is logistics/rail investments which Fitch expects will eventually be targeted for drop downs to the company's MLP, Valero Energy Partners (VLP). The next biggest part of discretionary spending will involve investments to boost light crude oil processing.

RECENT FINANCIAL PERFORMANCE

Valero's recent financial performance has been solid. Latest 12 months (LTM) EBITDA at March 31, 2015, was $7.76 billion, driven by strong crack spreads. Total debt also rose to $7.42 billion from $6.39 billion at YE 2014. The LTM figure includes the company's March $1.25 billion issuance, and $200 million of VLP debt that is consolidated on VLO's balance sheet but is non-recourse to VLO and has no cross defaults with parent debt. VLO's resulting debt/EBITDA at March 31, 2015 was 0.96x, EBITDA/interest coverage was 16.6x, and FFO/interest coverage was 14.0x. The company's FCF was $1.81 billion, consisting of cash flow from operations of $5.43 billion minus capex of $2.98 billion and dividends of $643 million. LTM results were negatively impacted by an unfavorable working capital swing of $667 million, which Fitch expects will be reversed over the next few quarters.

HIGHER SHAREHOLDER DISTRIBUTIONS

Given its strong cash flows and modest reinvestment opportunities in core businesses, VLO has increased its shareholder-friendly activity over the last few years. Currently the company targets 50% of its net income for shareholder distributions (dividends + buybacks). Dividends were a modest portion of Valero's total payout at March 31, 2015 (31%), with buybacks making up the remainder of distributions. This gives the company ample flexibility to dial back buybacks should conditions deteriorate. Valero recently increased its buyback authorization by $2.5 billion, for total authorization of $2.9 billion as of July.

MLP GROWTH

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 many new 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 is on the parent's remaining asset profile, and what the parent does with cash received from asset sales.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

--WTI oil prices of $50/bbl in 2015, $60/bbl in 2016, and $70/bbl in 2017;

--2015 capex of $2.8 billion;

--$2.5 billion in share buybacks in 2015;

--Crack spreads that revert to inflation adjusted historical averages over the forecast period;

RATING SENSITIVITIES

Positive: Future developments that may lead to positive rating actions include:

--Greater earnings diversification/evidence of lower cash flow volatility; and demonstrated commitment to lower debt levels which results in sustained (through the cycle) debt/EBITDA leverage at approximately the 1.25x level.

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 acquisitions, 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.

LIQUIDITY AND DEBT STRUCTURE

Valero's liquidity was robust at the end of the first quarter, and included cash on hand of $4.87 billion, three committed credit revolvers -- $3 billion unsecured revolver due November 2018 (98% availability); a $300 million revolver associated with VLP due December 2018 (33% availability); and a C$50 million revolver due November 2015 (80% availability])-- a $1.5 billion A/R securitization facility, a separate committed LoC facility of $550 million, as well as other short-term uncommitted facilities. Drop-downs to VLP should provide additional liquidity for Valero. In Q1, the parent dropped down product terminals at its Houston and St. Charles refinery to VLP for $671 million.

Valero's near-term maturities are manageable. Pending maturities include $950 million due 2017, and $200 million of VLP debt due 2018. 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.

OTHER LIABILITIES

Valero's other obligations were modest. Its asset retirement obligation at YE 2014 rose to $91 million, versus $31 million the year prior, driven mainly by accelerated dismantlement costs at the abandoned Aruba refinery. The deficit on the funded status of Valero's Pension Benefit Obligation increased to $472 million at YE 2014 versus $5 million the year prior. The main reasons for the decline included actuarial losses, and the absence of plan amendments seen in the previous year.

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.

FULL LIST OF RATING ACTIONS

Fitch affirms the following:

Valero Energy Corporation

--Issuer Default Rating (IDR) at 'BBB';

--Unsecured credit facility at 'BBB';

--Senior unsecured debt including Industrial Revenue Bonds (IRBs) at 'BBB'.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=988411

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=988411

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Mark C. Sadeghian, CFA
Senior Director
+1-312-368 2090
Fitch Ratings, Inc.
70 W Madison Street
Chicago, IL 60602
or
Secondary Analyst
Dino Kritikos
Director
+1-312-368 2090
or
Committee Chairperson
Eric Ause
Senior Director
+1-312-606 2302
or
Media Relations:
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Mark C. Sadeghian, CFA
Senior Director
+1-312-368 2090
Fitch Ratings, Inc.
70 W Madison Street
Chicago, IL 60602
or
Secondary Analyst
Dino Kritikos
Director
+1-312-368 2090
or
Committee Chairperson
Eric Ause
Senior Director
+1-312-606 2302
or
Media Relations:
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com