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Rating Action:

Moody's Affirms Valero Energy's Baa3 Senior Unsecured Ratings; Outlook Now Positive

26 Apr 2007
Moody's Affirms Valero Energy's Baa3 Senior Unsecured Ratings; Outlook Now Positive

Approximately $5 Billion of debt securities affected

New York, April 26, 2007 -- Moody's Investors Service affirmed Valero Energy Corporation's (Valero) Baa3 senior unsecured debt ratings and changed the rating outlook from stable to positive. Valero is North America's largest independent refining and marketing company, currently owning 17 oil refineries with nameplate crude oil distillation capacity of 2,805,900 barrels per day (bpd).

Today's move to a positive outlook reflects a degree of closure, and reduced uncertainty, concerning the leveraging outcome proportions of Valero's long-running review of strategic alternatives. Valero's review notably focused on the scales of stock buyback activity and refinery divestitures. Valero announced today that it received board of directors' approval to execute approximately $6.7 billion of common stock buybacks this year. That number roughly approximates Moody's mid-range expectation but it is substantially less than our cautionary yet realistic high-end estimate. Valero also had previously announced its plan to divest at least its Lima, Ohio refinery though we continue to believe asset sale proceeds would not be used for debt reduction.

The combination of supportive markets, the current known scale of buyback activity, and the expected scale of Valero's capital spending program over the next two years indicate support for higher rating in spite of the 2007 buyback program.

Overall, the positive outlook reflects (i) that the existing ratings anticipated a very sizable highly certain stock buyback program, (ii) our view that 2007 refining margins appear sufficiently strong to require only $3 billion to $4 billion of incremental debt, (iii) that any further buybacks in 2008 would be shaped to not substantially boost 2008 leverage above expected year-end 2007 levels (measured on complexity barrels), (iv) an assumption that Valero does not suffer further material unscheduled downtime beyond that of its McKee refinery.

To the degree 2007 and 2008 margins remain robust, and to the degree further stock buybacks do not further boost leverage or reduce Valero's credit cushion for mid-to-down cycle margins, the potential for an upgrade is increased. However, if it appeared that Valero would instead take actions that would significantly boost leverage beyond that expected with the current buyback program, Moody's would review the rating outlook. The positive outlook also would likely not survive an acquisition that significantly boosts leverage on complexity barrels, particularly if the outlooks for sector refining margins and Valero free cash flow materially weaken. To the degree weaker margins alone lead to materially higher leverage, the timing of an eventual upgrade could also be delayed.

The 2006 stock buyback program includes approximately $685 million to be acquired during the year to offset shares issued for the exercise of employee stock options and a new $6 billion program. The new $6 billion program replaces the current $2 billion buyback program and includes shares already purchased this year under that program. Of that $6 billion program, $3 billion will be acquired in a one-time buyback in second quarter 2007 funded with $3 billion of new debt, approximately $1 billion will have already been acquired by that date, and the remaining $2 billion will be acquired during second half 2007, funded roughly half from free cash flow and half from balance sheet cash.

While Valero generates a comparatively low EBITDA/barrel of throughput relative to other refiners, its returns, cash flows, and deleveraging have been supported by sustained robust sector light products cracking margins and historically very wide price differentials between light sweet crude oil feedstock and heavy sour crude oil feedstock. With gasoline and diesel pricing off of the more expensive light sweet crude oil barrel, VLO's substantial capacity to run cheaper heavy sour and medium-to-light sour crudes boosts total refining margins. While light/heavy crude oil differentials have been narrowing, we expect differentials to remain historically wide. Valero's comparatively low profitably measures per barrel do, however, indicate very substantial opportunities for organic capacity additions in important value adding processing units residing downstream from a given refinery's crude oil atmospheric and vacuum distillation towers.

Thus, after a long period of aggressive acquisition-driven growth, and lagging equity performance in spite of record sector refining margins, Valero signaled a change in strategy in 2006. Its share price fell 1% in through 2006, considerably weaker than other refiners, in spite of historic margins. Valero announced it would opt out of the bidding for particular refining acquisitions in an overheated upcycle asset market and that it would shift priorities to improving refining portfolio and shareholder returns. It also indicated that it had moved to harvest mode, potentially divesting one or more refineries deemed non-core to its portfolio. While Moody's believes Valero continues to be selectively interested in acquisitions, including international acquisitions, it has shifted focus in the meantime to organic capital projects which improve refinery yield.

Valero Energy Corporation is headquartered in San Antonio, Texas.

New York
John Diaz
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Andrew Oram
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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