A great blue chip performs year in and year out. It offers shareholders both stability and the potential for great gains. It exists and profits for decades. Thus, one of the most important traits for a true blue chip is an insurmountable competitive advantage.
Meet Valero Energy
Valero (NYSE: VLO) is the largest oil refiner in the United States. If that sounds like a rather commoditized and pedestrian business, consider these two facts:
- The United States consumes more than 20 million barrels of oil each day. That's approximately 25% of the global total, and it makes us by far the largest oil market in the world.
- The last refinery built in the United States was completed in 1976.
In fact, some 150 American refineries have been closed since 1980. And due to the investment, politicking, and permits needed to even think about breaking ground on a new refinery, it's unlikely that any new domestic refineries will be built -- even as we cope with rising energy prices and record energy consumption!
In other words, Valero, the biggest refiner for the biggest market in the world, is unlikely to face increased competition -- ever. If that sounds like one heckuva competitive advantage, then you know one reason why I think Valero is the best blue chip for 2007 and beyond.
Threats to dominance
An counterargument is that since it's impossible to build any new refineries in the United States, Valero will have a hard time growing. And that's true. While Valero can add capacity to existing plants and make other technological enhancements, it will not be building new refineries to spur growth.
But here's the good news: Valero's valuation is so low that it doesn't need to build new refineries in order to be a profitable investment.
The skinny on price
Valero trades for almost seven times earnings. Given its dominance, there's no reason why Valero won't enjoy a P/E closer to 10 -- the magic number for other energy behemoths such as ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX) -- as the uncertainty surrounding energy prices dissipates. Pump up Valero's multiple from current earnings, and we're looking at a $80 stock.
Then there's the nearly incalculable replacement value of Valero's assets. Since no new refineries can be built, what are Valero's facilities worth? Given the supply/demand equation, probably a lot more than they're being carried for on the company's balance sheet.
Fool's final word
Yes, Valero's price will fluctuate with oil prices in the near term. But given rising energy demand and the impractical nature of many alternative energy solutions, I find it hard to believe that oil prices will ever again fall below $45 a barrel. Taken together, Valero's valuation and competitive advantage make it the consummate blue chip. The company will continue to perform year in and year out, offer stability to shareholders with the potential for great gains, and exist and profit for decades.