Valero Stockholders: Should You Keep The Spin-Off Shares?

By Will Ashworth | April 08, 2013 AAA

Valero Energy (NYSE:VLO) announced April 4 that it was spinning off 80% of its retail business May 1 to existing shareholders. Spinoffs generally tend to outperform the parent company in the first 18 months of going public. Will this be the case for Valero? I'll have a look.

SEE: The Appeal of Company Spinoffs

Spin-Off Details
Valero shareholders will get one new share of CST Brands Inc. for every nine shares held in Valero (as of April 19th). The stock will trade on the New York Stock Exchange under the symbol "CST." The new company will operate 1,032 convenience stores in nine states as well as 848 retail sites in six Canadian provinces. The convenience stores both in Canada and the U.S. operate primarily under the Corner Store brand while gas is marketed under the Valero, Diamond Shamrock and Ultramar brands. CST Brands will be the second largest independent retailer of fuel and convenience merchandise in North America with nearly 1,900 locations. Approximately 60% of its U.S. business is in Texas, which just happens to have one of the stronger economies in the U.S. More importantly, 60% of its sites are owned rather than leased making it a real estate play as well. It does expect to pay a dividend although the amount is unknown at this time.

Previous Examples
Other energy companies have done what Valero is about to do. On June 30, 2011, Marathon Oil (NYSE:MRO) spun-off its refining and marketing assets into Marathon Petroleum (NYSE:MPC), which among other things, operates 1,460 gasoline convenience stores under the Speedway brand. Marathon Oil shareholders got one share of Marathon Petroleum for every two shares owned of the parent. Since the spin-off, MPC is up 95% while MRO has barely moved in the same time.

SEE: Cashing In On Corporate Restructuring

More recently, ConocoPhillips (NYSE:COP) spun-off its refinery and marketing assets May 1, 2012, creating Phillips 66 (NYSE:PSX) as an independent company. While its refining and marketing assets include selling gas to 8,500 Phillips 66-branded gas stations, the new company has focused on its pipeline and chemicals business. Coming up to its one-year anniversary, Phillips 66 stock is up 95% through April 5 versus 8% for its parent. Like the Marathon spin-off, ConocoPhillips shareholders got one new share of PSX for every two shares of COP.

Adjusting for the split, Marathon shareholders who hung on to their spin-off shares have achieved a total return of approximately 140% from both stocks in less than two years while ConocoPhillips shareholders have seen a total return of about 72% in less than one.

Are you beginning to see a pattern?

CST Brands' Profitability
Marathon Petroleum's revenues in 2011 (the full fiscal year prior to spin-off) were $78.6 billion with pretax income of $3.7 billion. Phillips 66's 2011 revenues (the full fiscal year prior to spin-off) were $200.6 billion with pretax income of $6.6 billion. Their pretax margins were 4.7% and 3.3% respectively. In comparison, CST Brands will be spun out with 2012 revenues of $13.1 billion, pretax income of $315 million and a pretax margin of 2.4%. Its U.S. retail operations are about one-third more profitable than its Canadian counterpart. The reason for that? Its Canadian division has far fewer convenience stores (261 in Canada vs. 1,032 in the U.S.) and the margins are higher when selling more than just gas.

Valuation
Phillips 66 at the time of its spin-off had a price-to-sales ratio of 0.11. Today it's 0.23. If Valero were to be spun-off at the same multiple, it puts a value on CST Brands of $1.44 billion or $18.95 per share. Also, as a separate company, CST Brands has the opportunity to expand its operations through acquisitions. With just $1.05 billion in debt at interest rates averaging 3.8%, it will have plenty of cash flow to add more convenience stores and gas stations in the next two or three years.

SEE: 3 Of History’s Largest Acquisitions

Bottom Line
CST Brands doesn't have the assets that either Phillips 66 or Marathon Petroleum had when they were spun from their respective parent companies. Having said that, I think it's been proven that separating the exploration and production business from the refining and marketing businesses is good for shareholders. Therefore, I expect that CST Brands' shares will follow a similar path over the next 18 months and double in value.

Disclosure: Will Ashworth does not own shares of any of the companies mentioned in this article.

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