01—Abstract
Summary
Summary of the 10-K filed March 21, 2003. Cited figures are marked; the original filing is the authoritative source.
Valero Energy's 2002 Form 10-K shows a company that grew dramatically through the December 31, 2001 Ultramar Diamond Shamrock (UDS) acquisition, which nearly doubled revenues to $26.98 billiona and expanded refining capacity to about 1.9 million barrels per day across 12 refineries.
However, earnings fell sharply: operating income dropped 53% to $470.9 millionb and net income fell 84% to $91.5 million ($0.83 per diluted share), driven by a 34% decline in refining throughput margin per barrel, narrowing sour crude discounts after OPEC cuts, weak gasoline and distillate margins, and heavy turnaround activity. Retail, now a second segment following UDS, contributed $128.5 million of operating income, partly offsetting the refining decline. Balance sheet leverage rose meaningfully, with long-term debt increasing to $4.49 billion from $2.52 billion, and the company's debt-to-capitalization ratio (net of cash) reached 50.4%.
Moody's downgraded Valero's senior unsecured rating to Baa3 in March 2003, citing high debt and the sustainability of refining margins. Looking forward, management stated that refining fundamentals improved sharply in late Q1 2003 due to low inventories, Venezuelan strike effects, and cold weather, and expects 2003 net income to be significantly higher than 2002, supported by a light turnaround schedule and UDS synergies.
Investors should weigh that outlook against several risks: the Unocal patent suit (seeking a 5.75 cent per gallon royalty), MTBE litigation, Tier II fuel standards requiring roughly $1 billionc of capital spending through 2006, and the March 2003 restructuring of Valero L.P. that reduced Valero's stake from about 73% to 49% and ended consolidation of the partnership. The company also disclosed significant off-balance-sheet structured leases with a maximum residual value guarantee of about $541 million.
02—Key points
Key Highlights
- Revenue nearly doubled to $26.98 billion (up 80%) in 2002, driven by the UDS acquisition completed December 31, 2001, which added refineries, roughly 4,100 retail outlets, and Canadian operations.
- Operating income fell 53% to $470.9 million and net income fell 84% to $91.5 million, or $0.83 per diluted share, versus $8.83 in 2001.
- Refining throughput margin per barrel dropped 34% to $4.06, reflecting a roughly 50% decline in sour crude discounts, weak gasoline and distillate margins, and reduced utilization during turnarounds.
- Retail operating income rose to $128.5 million from $1.9 million, reflecting the UDS retail network, though 160 stores were closed or divested and about 150 more were identified for closure.
- Long-term debt rose to $4.49 billion from $2.52 billion; Moody's cut Valero's senior unsecured rating to Baa3 (stable) in March 2003, and S&P affirmed BBB with a negative outlook.
- Operating cash flow fell to $272.3 million from $905.5 million, while capital investments of $779.5 million and debt reduction of $412.9 million were funded in part by $925 million from the Golden Eagle sale to Tesoro.
- Valero L.P. deconsolidation: Valero cut its stake from about 73% to 49% in March 2003, raising roughly $500 million in proceeds, and expects 2003 net income to be significantly higher than 2002.
03—Questions
Frequently Asked Questions
Why did Valero's earnings decline so sharply in 2002 despite higher revenues?
Revenues rose 80% because of the UDS acquisition, but operating income fell 53% to $470.9 million. The main causes were a 34% drop in refining throughput margin per barrel, caused by a roughly 50% narrowing of sour crude discounts after OPEC production cuts, weak gasoline and distillate margins across regions, and heavy refinery turnaround activity that reduced utilization. Higher interest expense ($285.7 million net, up from $88.5 million) and a $273 million drop in income tax expense also shaped the bottom line.
What does management expect for 2003?
Management said refining economics improved significantly in late February and early March 2003 due to low crude and product inventories, the Venezuelan oil strike, cold weather, and industry turnarounds. Valero expects refined product inventories to stay below average, which should support strong margins and wide sour crude discounts. Because Valero has a light turnaround schedule in 2003 and expects UDS synergies and strategic project contributions, it anticipates 2003 net income will be significantly higher than 2002. These statements are forward-looking and subject to the risks listed in the filing.
What are the most significant legal and environmental risks?
The Unocal patent suit seeks a 5.75 cent per gallon royalty on reformulated gasoline and asks for treble damages; the case is stayed pending PTO reexamination, and Valero believes it will prevail. MTBE groundwater suits in California and New York could have a material adverse effect if an adverse result occurs in a majority of cases. Environmental obligations include about $1 billion of capital for Tier II gasoline and diesel standards through 2006, roughly $500 million of environmental capex planned for 2003, a potential EPA Section 114 settlement requiring refinery capital improvements, and a Houston/Galveston SIP requiring about $60 million in NOx and HRVOC controls by 2007.
Why did Valero reduce its ownership of Valero L.P., and how does it affect the financials?
In March 2003, Valero L.P. issued 5.75 million common units and $250 million of debt, then redeemed about 3.8 million units from Valero. This cut Valero's ownership from roughly 73% to roughly 49%, and Valero will stop consolidating the partnership. Valero contributed storage tanks for about $200 million and a South Texas pipeline system for about $150 million to Valero L.P. under long-term throughput agreements. The move generated cash for Valero and reduces consolidated debt and minority interest, but Valero retains 100% of the general partner interest and remains the partnership's primary customer.
How leveraged is Valero, and what should investors watch regarding debt and off-balance-sheet obligations?
Debt-to-capitalization (net of cash) was 50.4% at year-end 2002 under the revolving credit facilities. Interest coverage (EBITDA to interest incurred) fell to 2.9x from 12.3x, and the bank covenant minimum is 2.4x through early 2003, rising to 2.75x thereafter. Valero also uses structured lease arrangements totaling about $642 million drawn, with maximum residual value guarantees of approximately $541 million, plus a planned $289.3 million purchase of the El Paso Corpus Christi East Plant. Investors should monitor covenant headroom, the rating downgrade's effect on borrowing costs, and the $3.5 billion-scale refinancing needs implied by the debt maturity schedule.
04—Continue