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Rating Action:

Moody's places Valero Energy ratings under review for upgrade

08 Feb 2008
Moody's places Valero Energy ratings under review for upgrade

New York, February 08, 2008 -- Moody's Investors Service placed Valero Energy Corporation's (VLO) ratings on review for upgrade. The outlook had been positive.

In spite of a cyclical downtrend in refining margins, the move to a review for upgrade reflects conservative leverage at year-end 2007, providing room to absorb a degree of expected higher leverage this year; management's statements to Moody's on the timing, scale, and use of after-tax proceeds from potential asset sales as the company evaluates its strategic alternatives, which include assessing opportunities to divest refineries to optimize its asset base; potential ranges of resulting 2008 leverage; ample back-up liquidity; and its pro-forma solid position as a large, geographically diversified independent refiner with an investment grade business profile.

Timing stock buyback activity to coincide with potential asset sale proceeds is a key aspect of VLO's ability to improve its current ratings. Simultaneously, Valero is conducting an important heavy multi-year capital spending program, led by expected major value adding projects at its Lake Charles, Port Arthur, and Quebec City refineries. If the ratings are upgraded, Moody's would subsequently reevaluate the new ratings if it appears that VLO's profile will veer from our view of suitable leverage for the ratings and in relation to the cash flow outlook.

Valero's geographic diversity, with a large refining portfolio in four key regions, mitigates the impact of inherent real unscheduled downtime risk and geographically diversifies its regional margin trends as well. VLO's deep conversion capacity also gives it greater diversification of its crude oil sourcing activity and allows it to also to convert cheaper low-quality crude oil and heavy intermediate feedstock into light refined products. In each of the possible near term pro-forma refining portfolio scenarios, VLO would clearly retain the scale and diversification of an investment grade refiner.

In the absence of an extended serious downturn, a higher rating would appear able to withstand an increase in debt of in the range of $2 billion. At this point, it appears that management's potential 2008 actions, including the ultimate scale of stock buyback activity and its use of after-tax proceeds from a potential divestiture of the Aruba refinery (one of the plants for which the Company is pursuing strategic alternatives), renders leverage in a suitable range for the ratings. This general proportionality would need to be maintained in the event of additional divestitures.

Today's rating action follows Moody's discussions with VLO executives concerning the leverage parameters within which it will execute its de-capitalization program. That program involves large 2008 stock buyback activity, one to three potential refinery divestitures as it reviews strategic alternatives for certain plants, and use of any potential asset sale proceeds to fund stock buybacks and heavy capital spending. Moody's expects VLO's capital spending and buyback activity to substantially exceed cash flow, barring a return to strong up-cycle refining margins. Moody's also believes margins will be on a generally weakening trend over the next several years.

Refining is a highly volatile and cyclical business and we believe that margins will continue to moderate through the decade. Regionally, VLO's softest margin outlook appears to be in its West Coast market. In addition to softening margin trends, the ratings are also restrained by the potential for leveraging acquisitions, including foreign acquisitions. However, all other things held equal, VLO enters the year with sufficiently low leverage to absorb a degree of re-leveraging without jeopardizing a higher rating.

VLO is North America's largest independent refining and marketing company, currently owning 16 oil refineries with nameplate crude oil distillation capacity of 2.6 barrels per day (bpd) and, including intermediate feedstock, 3.1 million bpd. VLO has one of the largest deep conversion capacities in North America. Its current portfolio of refineries displays a somewhat above average Nelson Complexity Index of 11.1. VLO is evaluating strategic alternatives for one to three refineries and each of the potential pro-forma scenarios would increase its current Nelson index. The pending major capital spending programs would further increase VLO's value adding capacity and complexity downstream from crude oil distillation.

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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