Oil prices continue to trade at elevated levels, keeping energy companies in the spotlight. High prices of the commodity generally brighten the outlook for exploration and production players, but the overall business environment is also favorable for refining companies due to several fundamental factors. Against this backdrop, let us compare two energy firms, Valero Energy Corporation VLO and SM Energy SM, to determine which stock offers a better opportunity now.
VLO to Gain on Resilient Demand & Tight Refining Capacity
The global refining capacity is constrained, and fuel inventories are low. On the demand side, gasoline, diesel and jet fuel remain resilient. This means people are still driving and flying quite often, while diesel demand suggests transportation, freight, agriculture and industrial activity are still holding up. As a result, with busy refineries and fuel not available in abundance, refining margins for refiners like VLO are quite strong. Thus, despite the price of raw crude being high now, as reflected in the price of West Texas Intermediate (“WTI”) crude, which is trading at more than the $90-per-barrel mark, refiners like VLO are still in the sweet spot now.
High Oil Prices a Key Driver of SM's Energy Operations
The Iran-war shock is driving the high crude oil prices. The U.S. Energy Information Administration (“EIA”) in its latest short-term energy outlook projected WTI at $85.68 per barrel this year, higher than $65.40 last year. A highly favorable pricing environment for the commodity is likely to continue supporting SM Energy’s exploration and production activities, which derive a significant proportion of its earnings.
To have a glimpse of its upstream assets, the company has a strong footprint in shale basins in the United States, comprising the Permian, the most prolific basin in the United States, the DJ Basin and others. The company mentioned that its operations are spread across roughly 237,000 net acres in the Permian and almost 303,000 net acres in the low-cost DJ Basin.
Considering the ongoing high oil prices and footprint in low-cost, high-quality basins, the business outlook of SM Energy seems promising.
VLO Has Stronger Balance Sheet, Capital Return Story
The balance sheet of VLO has lower exposure to debt capital compared to SM. This is reflected in the fact that VLO’s debt-to-capitalization of 29.9% is lower than the 53.7% of SM Energy.
When it comes to the capital return, VLO’s story is more proven and has been rewarding shareholders for the long term. On the flip side, SM is now primarily focusing on lowering its debt burden, following which it may commence repurchases in the second quarter.
VLO or SM: Which is a Better Stock?
Coming to the price chart, both Valero Energy and SM Energy have had a strong run-up over the past year. Over the period, VLO has jumped 88.9%, while SM gained 41.7%.
On a relative basis, VLO is trading at a 7.48x trailing 12-month Enterprise Value to Earnings Before Interest, Taxes, Depreciation and Amortization (EV/EBITDA), which is a premium compared with SM’s 6.00x.
Thus, it has become evident that investors are willing to pay a premium for VLO over SM. This represents that investors are betting on VLO’s handsome refining margins, stronger balance sheet and more proven shareholders' reward policy despite high oil prices aiding SM’s bottom line. Valero Energy currently sports a Zacks Rank #1 (Strong Buy).
However, those who already own SM stock can stay invested. You can see the complete list of today’s Zacks #1 Rank stocks here.
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Valero Energy Corporation (VLO): Free Stock Analysis Report
SM Energy Company (SM): Free Stock Analysis Report
This article originally published on Zacks Investment Research (zacks.com).