>RIL may bid for US refiner Valero

Possible RIL bid for largest independent US refiner Valero?

According to press speculation, RIL may bid for US refiner Valero (see Valero Energy Corp., 27 October 2011). Valero is the largest independent US refiner with 2.8m b/d of refining capacity (Nelson complexity of 11.3). Valero can process heavier/sourer, cheaper crudes, which means lower earnings volatility vis-à-vis peers. A bid for Valero at US$48/share (as per some press reports) appears aggressive but would be earnings accretive if Valero’s profit is over US$2.2bn in our opinion. At BofAML’s estimate of US$3.1bn, a Valero acquisition would boost FY13 earnings by 8-19%. Retain Buy.

Acquisition EPS accretive if Valero profit over US$2.2bn

RIL’s net debt is US$3.5bn (gross cash US$15.6bn) and is set to turn net cash assuming no big acquisition by end of FY12. RIL has been looking for acquisitions and had even bid for LyondellBasell in 2009. We believe RIL could bid for Valero. Some reports suggest RIL’s bid may be at US$48/share (82% higher than Oct 27 closing of US$26.2) while BofAML PO for Valero is US$36. Acquiring a 100% stake in Valero at US$48/share would cost US$27.5bn (net debt US$4,6bn). Valero’s acquisition would be earnings accretive if Valero's FY13 net profit is higher than US$2.2bn. BofAML net profit for 2012 is US$3.1bn and consensus is US$2.5bn. At US$48/share its 2011-12 PE is 9.0-9.6x and EV/EBITDA 4.7-5.4x. US and Valero’s refining outlook the key

Paying US$48/share for Valero would mean 65% higher valuation per complex barrel vis-à-vis RIL’s new refinery built in 2009. We believe some premium is justified if Valero’s stronger GRM in 2Q 2011 (US$11.6/bbl vis-à-vis RIL’s US$10.3/bbl) is sustainable. 17% of Valero’s throughput in US mid-continent gains from weak WTI prices but a key question is how long are these gains sustainable?

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