Merrill credit analyst says Valero's lack of cash flow offsets forecast of better earnings

By Ronda Fears

Nashville, March 7 -Valero Energy Corp. boosted its guidance for earnings per share above analysts' expectations but cash flow is still lacking, noted Merrill Lynch & Co. high-grade analyst Jason Mandel.

"We remain underweight on Valero Energy (Baa2?/BBB) given a lack of free cash flow despite a remarkably strong refining margin environment," Mandel said in a report.

"Our concern lies with the company's lack of ability to reduce debt, exhibited by solid 1Q03 fundamentals matched with our estimate of no free cash flow.

"Additionally, we expect reported net debt to be up by approximately $250-300 million at the end of 1Q03 due to neutral free cash flow and the $289 million cash buy-in of the Corpus Christi refinery from El Paso."

Valero's bonds initially traded up by 15 basis points on the news, he said, but then retrenched by about 5 bps and the 6.875% of 2012 are now bid at about 215 bps over the comparable Treasury.

Moody's Investors Service downgraded Valero's debt on Thursday, putting the subordinated debt in junk territory. Senior unsecured debt was lowered to Baa3 from Baa2 and subordinated debt to Ba1 from Baa3.

Valero on Thursday provided a first quarter forecasts for the first time, putting expected earnings at $1.10 per share, significantly above consensus expectations of 82c per share, citing higher refining margins across the U.S. and wider differentials between heavy and light crude oil for the improvement.

Free cash flow is still lacking, though, Mandel said.

The analyst calculates the company will generate $401 million of EBITDA and $275 million of operating cash flow. Against that, $275 million of capital spending and $289 million for the Corpus Christi buy-in and common dividends puts adjusted free cash flow at negative $300 million.

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