Tuesday, July 29, 2008

Added VLO to FGI and SSS

In my June 2 posting, "Avoiding Oil Related Stocks", I said I was in the bubble camp when it came to oil prices. This is why we had no energy stocks in the Forbes Growth Investor and only one in the Special Situation Survey.

Now that oil prices are starting to ease, we decided it was a good time to add an energy stock to both newsletters. That may seem a bit nonsensical, but the stock we added is a refiner. High oil prices have squeezed margins at refiners. With oil prices falling, margins should expand once again. As a result, we decided to add Valero Energy (VLO) to both newsletters. In fact, in today's earnings release, Valero said gasoline margins (aka the crack spread) fell to $6.60 per barrel in the second quarter of 2008. They were at $28.95 per barrel a year ago. This explains why the stock price has been cut by more than half during the same time.

Of course, the crack spread won't expand if gasoline prices fall as rapidly as oil prices. While we certainly expect gasoline prices to ease, we think they will hold up better than oil because they didn't climb as much as oil to begin with.

While we expect VLO's profit margins to improve, we think the bigger risk over the near term has to do with volumes. Gasoline demand is falling sharply as drivers respond to high prices by cutting back, car pooling, and switching to more efficient vehicles. That's a risk we are willing to take. Low price multiples and a recent dividend increase make this stock extremely attractive.