Better Buy: Calumet Specialty Products Partners LP vs. Valero Energy

While Calumet Specialty Products Partners (NASDAQ: CLMT) and Valero Energy (NYSE: VLO) both operate refineries, these two companies couldn't be more dissimilar. That's because Calumet is a master limited partnership that makes more money manufacturing specialty products than it does on refining. Meanwhile, Valero is the largest independent refiner in the country. Further, it owns a separate MLP, Valero Energy Partners (NYSE: VLP), which operates pipelines and storage facilities.

Those different focuses aside, an even more glaring discrepancy between these two is their financial situations. Calumet's balance sheet is a disaster, which forced it to suspend shareholder distributions last year, while Valero maintains a top-tier financial position that has allowed it to continue increasing cash returns to investors. Those reasons, when combined with its visible growth prospects, make Valero the clear better buy.

A look under the hood

As noted, one of the most significant differences between these two companies is their financial profiles:

As that table shows, Calumet Specialty Products Partners' financial situation is in incredibly poor shape. The company has junk-rated credit due to a deeply concerning leverage ratio. Though, it is worth noting that leverage has come off its high of 22 times last September due to some improvements in the company's refining business and a slightly larger cash position. Meanwhile, additional enhancements are on the way after the company recently agreed to sell one of its refineries for $435 million in cash. If it applied the entire proceeds of that deal to debt reduction, total debt would decline by more than 20%.

That said, even with those improvements Calumet would still be no match for Valero. The refining giant boasts a solid investment grade credit rating, backed with a low leverage ratio that's currently in the middle of the company's target range. Further, it has a whopping $5.2 billion in cash on its balance sheet against just $8.5 billion of debt. Meanwhile, the company owns a significant stake in Valero Energy Partners, which gives it a vehicle to further bolster its balance sheet because it can continue dropping down its logistics assets in exchange for cash.

Driving shareholder returns

Calumet's abysmal financial situation forced the company to reduce cash outflows, including suspending investor distributions and slashing capital spending. That inability to return money to investors and invest in growth projects has weighed heavily on the company, causing it to lose nearly 75% of its value over the past three years. While the company is working on several self-help initiatives to boost earnings, it doesn't have the financial resources to pursue needle-moving growth at the moment.

Valero, on the other hand, has continued to generate robust cash flow, which when combined with its strong balance sheet, has allowed the company to return money to investors and make growth-focused investments. In fact, over the past year, the company has returned a peer-leading $2.5 billion in cash to investors via buybacks and dividends. Meanwhile, the refiner expects to invest $1 billion per year in high-return growth projects through 2021, which it estimates will contribute an incremental $1.2 billion to $1.4 billion of annual EBITDA by 2021. That combination of growth and shareholder returns should enable Valero to continue creating value for investors and build on the nearly 70% total return it has delivered over the past three years.

Not worth the gamble

Some investors will look at the fact that Calumet is starting to improve as an opportunity to score a big-time gain as it tries to recapture lost ground. While that's a possibility, there is a much higher risk associated with the company, which isn't worth the potential reward. Valero, meanwhile, has a clear path to grow, which when combined with its top-notch balance sheet and history of returning cash to investors makes it a lower risk opportunity.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.