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Should I Do It? Tracking Valero

This independent refiner could keep rallying, or it could be a value trap.

Valero Energy

(VLO) - Get Valero Energy Corporation Report

is the nation's largest independent petroleum refiner, with about 15% market share and a network of 5,000 gasoline stations. The stock has rallied 9% year to date, closing Tuesday at $55.30 a share, though it is currently valued at just eight times expected full-year earnings of $7.02.

The company posted better-than-expected fourth-quarter results Feb. 1, as it benefited from lower energy prices. Valero earned $1.59 a share, which was a full 16% ahead of the consensus analyst estimate. Even so, profit declined year over year for the first quarter since 2002, and management guided for a further 15% annual earnings decline in 2007.

At these levels, the stock remains 21% below its 52-week high, and I'm here to answer readers' questions. Should I do it? Does Valero have the fuel to keep rallying, or is the stock a value trap in disguise?

After building up the company through more than a dozen acquisitions in recent years, including the $11 billion 2005 purchase of Connecticut-based refiner Premcor, management discussed a change in strategy on the post-earnings conference call. By upgrading its 18 refining plants, Valero believes it can unlock $1 billion of annual earnings leverage. The company has also hired an investment bank to explore strategic alternatives for its Lima, Ohio, location.

The days of $3-a-gallon gasoline seems like an eternity ago, and, in fact, the average national price is down 30% from its peak last August. That said, I believe that with Valero's efficiency measures it will continue to generate solid profits over the next several quarters.

According to an upgrade from Prudential earlier this month, the company can generate $6 billion of operating cash flow in 2007, compared with a capital budget of $3.5 billion. This expected free cash flow allowed management to boost the company's quarterly dividend 50% last month to 12 cents a share.

The 0.9% yield is just half of what the average

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stock offers, but still relatively high for the energy patch. Last October, Valero also committed to buy back $2 billion (36 million shares) of its stock.

These efforts should help place a floor under the shares, which are already trading at the lowest earnings multiple since 2002 and a 19% discount to the company's five largest competitors, according to Bloomberg. Valero's restructuring plan will not be successful overnight, but if management can show some real progress over the coming quarters, I believe the stock can trade back up toward the mid-$60s.

David Peltier is a research associate at TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Peltier appreciates your feedback;

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