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Sweet Quarter at Valero

The stock surges as the refiner continues to make money processing 'sour crude.'


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knows how to keep its word.

The giant refiner has once again delivered on its promise to beat Wall Street expectations, this time with its biggest upside surprise in recent history. The company posted fourth-quarter operating profits of $1.89 a share -- toppling the $1.44 consensus estimate -- that came in more than three times higher than a year ago. Moreover, it pledged to keep topping analyst expectations going forward.

Valero pointed to its ability to process discount-priced crude oil as a major reason for its record quarterly earnings. For months,

has also highlighted this capability when presenting Valero as an underappreciated stock.

"Our ability to process these lower-cost feedstocks greatly enhanced our margins and allowed us to far exceed analysts' estimates for the quarter," announced Valero CEO Bill Greehey. "As was the case in the fourth quarter, we do not believe that analyst estimates for the first quarter or full year adequately reflect the earnings power Valero has from these wide discounts."

Prior to Tuesday's upbeat report, analysts were looking for earnings to come in at $6.17 a share for 2004 and then drop 22% this year. Instead, Valero posted 2004 operating profits of $6.66 a share and promised even better results for 2005.

The stock rocketed 8% to $56.18 -- a 52-week high -- on the bullish update.

Sweet and Sour

Valero's ability to process heavy, sour crude oil made a huge difference.

The company saw its fourth-quarter refining profits nearly triple to $884 million. It attributed more than $800 million of that amount to a rise in both sour crude discounts and sour crude throughput levels.

"Even though refined product margins declined from third-quarter levels in every region, we had record earnings because of our substantial leverage to sour crude discounts," Greehey said. "Our fourth-quarter results dramatically underscore the feedstock and complexity advantage Valero has over its peers."

A few bullish analysts have clearly taken notice. Douglas Terreson of Morgan Stanley believes the sector has entered a "golden age in refining" and finds Valero and



-- with their ability to process heavy, sour crude oil -- especially attractive. Meanwhile, Jay Saunders of Deutsche Bank says he is now "warming" to the idea that Valero may go on to set even bigger records this year.

Still, he warns of a risk -- a potential drop in gasoline prices -- that can threaten all refiners.

"If gasoline's weak this year, an earnings disappointment could be costly," wrote Saunders, who nevertheless has a buy recommendation on Valero's stock. "But until then, crude discounts are powerful."

For now, Valero says, margins remain at "exceptional levels." Moreover, the company adds, recent crude discounts are nearly double what they were just one year ago.

Thus, the company is convinced that its strong rally will continue.

"Last year clearly demonstrated that we have entered a new era for our industry, with worldwide refining capacity tight and getting tighter," Greehey said. "And with our industry-leading geographic diversity and superior leverage to sour crude discounts, we are firmly convinced that our stock continues to represent a tremendous value to investors."