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Contributors: Douglas McIntyre Jon C. Ogg

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Tuesday, October 03, 2006

Implications of Valero's Guidance (Warning)

Earnings warnings are bad for companies, right? Earnings drives the market, right? Stocks that warn trade lower, right?

Well, it depends. Think of how many homebuilders warned earnings would be lower than projected and then saw their shares rise.

Valero (VLO) is the first of the big refiners to come clean with guidance. Shares of VLO fell 5.4% to $48.17 on the day because of weak oil prices and the stock did initially fall another 1% after the news was out, but VLO is actually trading up almost 1% now from its closing price.

There is no way to know where this opens in the morning and no way to know how many street analysts will lower guidance and play catch-up in the morning, but a lot have already lowered their ratings and their estimates in the sector.

VLO traded up at $70.00 in April and spent most of the summer north of $60.00. At $48.00, you have to wonder how much has been priced into this stock and if you start running some annualized forward P/E ratios it will start to make you wonder if they overshot on the stock sales. $45.85 is the yearly low, although if you go back 2 years you are talking about a $20.00 stock.

VLO put earnings at $2.25 to $2.35 on the quarter, and that is actually on record income. It also excludes a $132 million pre-tax gain on their sale of the 40% interest in Valero L.P. The street has estimates of $2.40 to $2.50 depending on which source you use. The street has taken note that energy prices are falling too and they have alreadt greatly trimmed estimates over the last 30 days.

"Despite the recent weakness in gasoline margins, distillate margins and sour crude discounts remain very good," Valero Chief Executive Bill Klesse said in a statement. "The seasonal fall in gasoline margins was more severe than we had expected......we believe that with the commencement of fall maintenance in both the U.S. and Europe, and with the falling retail pump prices supporting continued strong gasoline demand, the picture for gasoline margins is improving."

The truth is that if oil and energy prices keep falling most oil stocks and stocks tied to oil will likely trend lower with the commodities, even if they have a lot of forward sales contracts locked in. That is just unfortunately what happens. Merrill Lynch had already downgraded the sector today. If oil stabilizes, this company is going to look fine. But oil falls into the $40's it probably won't matter what the companies say about their earnings.

Jon C. Ogg
October 3, 2006

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