The 52-week low is $29.70, and the Wall Street analyst community remains very negative on the shares of the San Antonio-based company – even though it beat analysts admittedly reduced expectations for both revenue and earning.

The $64 million question (*) is this: Is it time to buy? During the past year, I have watched as many ventured into this stock for a trade – only to get clobbered. The key factor in determining Valero’s profitability – and its stock price – is the refining profit margin, known as the “crack spread” in industry parlance. This is the difference between the cost of oil purchased by Valero and the price it can get for the distillates it obtains by refining the 3.1 million barrels of crude oil that it processes daily.

Recently, the overall industry crack spread has been narrowing. In fact, it has been for some time as governments around the world and gasoline companies actually try to hold down the pain motorists feel at the gas pumps.

The “perfect storm” that hit Valero this year had several catalysts:

• First, we watched as the price of crude oil soared exponentially, the result of rocketing global demand overseas and a lack of effort in both the United States and other countries to increase production.
• Second, demand for distillates in the United States waned as the U.S. economy slowed down and distillate prices soared trying to catch up with crude prices. This made it very difficult for the increases in the price of gasoline to be able to keep up with increases in the price of oil, compressing Valero’s crack spreads from last year.

That was the bad news.

The good news is that crack spreads in the second quarter have increased from the first quarter of this year. Also, since Valero’s refineries can process the cheaper “heavy sour” crude oil, the company has a sustainable competitive advantage over other refiners, giving its refineries staying power through rough times like these. For very-long-term holders, this is when you buy stocks such as this one; since the weaker rivals often disappear (the rivals either eventually get shut down, get sold off – or both), and the strong players emerge as the victors.

In the refinery sector, that strong player – and eventual victor – is Valero. But we are not there yet, and the lack of expansion in refining capacity in the U.S. market over the past decade has established a definite floor under crack spreads, meaning there’s only so low they can go.

The U.S. government expects crack spreads to improve moving forward, but those spreads remain well below where they were in last year’s second quarter. That’s good because it means there’s room for improvement – in both the margins and the share prices.

Another plus is that as oil prices have been dropping precipitously recently from the high of almost $150 per barrel, crack spreads have been increasing. And the drop in prices of natural gas, which is an input to Valero’s refining process, has also declined, further adding to margins.

The bullish argument, then, is this: The drop in oil prices, and sequentially expanding margins (from quarter to quarter, as opposed to year over year), will combine with the low valuation in Valero’s stock price (the current Price/Earnings Radio is 6.76, while the Forward P/E is 11.22) to boost the company’s share price, which appears to have bottomed of late.

This bullish case could very well be accurate; unfortunately, it’s still too difficult to call. And here’s why:

• The U.S. economy isn’t going into a recession. That means U.S. demand for petroleum products won’t abate as much as analysts expected, and may actually soon begin to escalate anew (even if it’s somewhat reduced because of energy-reduction initiatives).
• Emerging-market demand will continue to escalate as incomes rise and more consumers buy cars. The respite there also is likely to be a temporary manifestation: They have curbed gasoline demand subsidies because of the inflationary impact of high crude prices and food prices; as crude prices are abating, demand is likely to reaccelerate.
• Evidence about the resilience of emerging markets has been abundant of late. There was Cisco System Inc. (CSCO), which reported stronger-than-expected sales and profits last week, thanks largely to strong performance in Mexico, Russia and Asia – and especially China. There was the comment by Jeffrey R. Immelt, chief executive officer for industrial giant General Electric Co. (GE), who talked of the undiminished strength in the emerging markets – with a specific reference to the Asian infrastructure boom. And there’s the launch of the $2,500 car – the Nano – in India by Tata Motors Ltd. (TTM), a domestic carmaker with global aspirations.

It’s worth noting, too, that most of these markets outside the United States, which are currently slowing, have plenty of room to cut interest rates. And some will be able to do so, should the prices of commodities and other goods continue to decline.

Unfortunately for our evaluation of Valero, in addition to the ongoing gyrations in oil prices there’s substantial uncertainty being created in Washington, largely because of the ongoing political battle that’s focused on the lifting of the ban on drilling in offshore U.S. waters. The mere possibility of this ban being lifted has added much downside pressure to oil prices by motivating profit-taking by the speculators who had previously been betting that long-term prices were destined to head higher.

Hence, while Valero’s beaten-down shares appear very appetizing right now, and while the shares seem well positioned for a near-term speculative trade, there’s still too much uncertainty to call this an actual “Buy” for investors. Unless we see much-lower oil prices, which would rekindle gasoline demand in the U.S. market and expand Valero’s margins, the upside, if any, in Valero’s stock will remain very limited. So I cannot recommend to buy Valero here. However, since Valero’s stock has come down dramatically, and the company still is profitable (they are still profitable, show mildly expanding sequential margins, and management is committed to support the stock with buybacks), neither do I see a compelling reason to call it “Sell” here. So I will stick with a tenuous “Hold” until we can at least start resolving the uncertainties surrounding oil prices and the U.S. economy.

Action to Take: HOLD Valero shares as we await a bit more certainty in both the oil sector and the U.S. economy.

[Editor’s Note: Horacio Marquez was working as a vice president of the Merrill Lynch Emerging Markets Fixed Income Group in 1994 when he correctly predicted that both Argentina and Mexico were headed for currency crises - cementing his reputation as an expert on both the emerging markets and on the nuances of global finance. Now Marquez brings that expertise to you with his newly created "Shadow Stock Trader" service. To find out how to subscribe, please click here. "Buy, Sell or Hold" is a brand-new Money Morning feature that so far has covered such companies as Cisco Systems Inc. (CS), ABB Ltd (ADR: ABB), Cummins Inc. (CMI), and Chevron Corp. (CVX). Next week, Marquez will write about Berkshire Hathaway Inc. (BRK.A, BRK.B), the investment vehicle run by famed investing guru Warren Buffett. ]

(*) It was once the “$64,000 question,” but inflation has done its work all too well.

Source: Buy, Sell or Hold: Valero Energy Corp.

Indeed, the Wall Street consensus called for Ford to lose 27 cents per share – instead, Ford lost 62 cents per share. Even though Ford outperformed in its European, South American and Asia-Pacific operations, the massive undertow of its U.S. operations was just too much to overcome.

That’s not really a surprise, you see, since auto sales in the United States are the weakest they’ve been since 1993, reports J.D. Power and Associates.

U.S. auto sales have been shot down by three key factors:

• The negative wealth effect of the U.S. housing market.
• The credit crunch for the last year or so.
• And, lately, the meteoric increase in the price of oil and gasoline.

All of these detract from consumer wealth and purchasing power even as they weaken the general economy.

But there’s an additional catalyst for Ford’s malaise: While economies of scale in the car industry are very important and volume is critical to allow to keep manufacturing costs down, compensation for Ford’s work force is problematic.

For decades, Detroit’s “Big Three” – Ford, General Motors Corp. (GM) and Chrysler Corp. (now Chrysler LLC) – which once ruled the worldwide auto industry, have been losing their leadership. Call it the typical story of success sowing the seeds of destruction.

With their global dominance of the auto industry, the U.S. Big Three grew complacent and, despite their market and technological leadership, fell into the trap of granting overly rich compensation-and-benefit packages to their work forces. How rich? The pension plans were super-generous and the health-care plans required no co-payments from workers.

Then came the double-whammy that put the U.S. auto sector on a path to destruction: U.S. health-care costs ballooned and carmakers watched their work forces age, forcing the automakers to assume a massive cost burden – one that they ultimately couldn’t afford.

By 2000, in fact, that cost burden was so huge that the companies were no longer making money from automobile production; any profits they were reaping actually came from their auto-financing arms, which finance auto sales.

These longer-term trends left Ford and GM in a highly vulnerable position. And it likely blunted innovation and kept the companies from quicker development of hybrid vehicle lines.

Then came the energy bubble.

The meteoric rise in the price of oil has put an already heavily cost-burdened U.S. auto industry in a near-panic-mode situation, since customers have shifted away from Detroit’s line-up of trucks and sport-utility vehicles to smaller, more-fuel-efficient cars and hybrids offered by Japanese rivals.

With Ford, at least, there has been major progress on the cost-cutting front. In the first quarter, under the leadership of Chief Executive Officer Alan R. Mulally, the very able engineer who turned around The Boeing Co. (BA), Ford was able to secure a new contract with the United Auto Workers Union that allowed for reductions in 20% of personnel. This allowed Ford to start the process of discontinuing unprofitable models without having to keep the workers employed.

At the same time, Ford announced cuts of another 4,000 employees in the most recent quarter, and is in the process of starting another round of layoffs of some 15% of salaried personnel.

Ford opted to cut loose Land Rover and Jaguar to raise cash and improve profitability. It’s launching new, fuel-efficient cars and has dramatically improved the quality of its products – especially its cars.

To deal with the recent effects of the economy, it has postponed the launch of its redesigned F-150 pickup truck, which has been the industry’s standard-bearer for decades. That’s a huge move, given that the Ford pickup truck is an icon in the industry, with consumers, with collectors, and even with hot rodders – and has been for generations — reaching all the way back to the Ford Model T and Model A trucks of the 1920s and 1930s.

Managing liquidity and maintaining enough cash to complete the restructuring plan is a big challenge for Ford, given the shifting market tastes and the highly uncertain economic environment. Should the company successfully navigate these dangerous financial straits, Ford’s stock will likely enjoy a major increase, generating huge capital gains for current stockholders.

But there is a significant probability that the company’s equity holders will get wiped out and the bondholders will end up owning the company. This reality is reflected in the upfront cost of almost 30% in credit insurance needed for certain Ford obligations.

Therefore, while Ford’s restructuring plan seems to be moving forward well and even accelerating in pace, and Mulally has distinguished himself with his execution, the unpredictability of oil prices and the slow resolution of the housing crisis ahead makes this stock very speculative. I cannot recommend it without warning that Ford shareholders must accept a large degree of risk and accept the potential for some pain.

A much better play, yet also with the potential for pain, is to look for convertible debt, with the view that even in a restructuring, bondholders will end up owning the company and capture the huge upside that this franchise will have once it finishes dealing with its problems and is able once more to deliver competitively the high quality products that it was known for.

Action to Take: BUY Ford Motor Co. (but as a highly speculative position). This once-great U.S. automaker may once again find its way, but possibly only after the bondholders end up owning the company. If you are going to buy Ford shares, keep the position small.

A Better Buy: Ford debt, especially senior convertible issues.
[Editor’s Note: Horacio Marquez was working as a vice president of the Merrill Lynch Emerging Markets Fixed Income Group in 1994 when he correctly predicted that both Argentina and Mexico were headed for currency crises - cementing his reputation as an expert on both the emerging markets and on the nuances of global finance. Now Marquez brings that expertise to you with his newly created "Shadow Stock Trader" service. To find out how to subscribe, please click here. "Buy, Sell or Hold" is a brand-new Money Morning feature that so far has covered Cisco Systems Inc. (CS), ABB Ltd (ADR: ABB), Cummins Inc. (CMI), and Chevron Corp. (CVX). We continue to appreciate all the readers who are writing to us, suggesting stocks they’d like to see analyzed.]

Source: Buy, Sell or Hold: Ford Motor Co.

So begins a letter from one of our more-dedicated readers.

In today’s markets, it is extremely difficult to find winners. With a market beset by soaring oil and energy prices, the forced liquidation of securities by large financial institutions that are quickly urged to comply with the U.S. Federal Reserve’s capitalization requirements and the rest of the market afraid of its own shadow, rumors proliferate and bear raids abound.

Stocks that already represent a fine value get hit nonetheless and become even deeper bargains. Yet, it is precisely in these circumstances, as the Chicago Board Options Exchange Volatility Index – usually referred to as the VIX Index – is regarded as a proxy for fear in the markets. The index is once again quickly approaching the July 2007, January and March 2008 spikes above 32 that marked the broader market’s tradable bottoms. We have to remain vigilant and look to scoop up bargains if this market ends up as a fire sale.

Enter Cummins Inc. (NYSE: CMI). This no-nonsense Midwest industrial company is almost 100 years old, has been trading publicly since 1947, and is best known as the maker of bulletproof diesel engines.

But the Columbus, Ind.-based company is actually much more. Indeed, in many ways it’s actually the ideal Money Morning/Money Map Report stock pick: It serves basic industries, is diversified globally and just boosted its dividend payout 40%.
Cummins does business in four areas:

• Diesel and natural-gas-powered engines (52% of the company’s overall revenue).
• Electric-power-generation systems distribution systems (19% of revenue).
• Power-generation systems (19% of revenue).
• Engine components (10% of revenue).

The company holds leadership positions in all of its product areas. All these lines are in the “sweet spot” of increasing growth rates and margins due to the specific reasons that differentiate them from the rest of the market.

Very importantly, Cummins enjoys strong, sustainable competitive advantages in every segment of its business. It has well-integrated product plans, focused on being the low-cost producer and developing strong distribution-and-servicing channels in all its markets across the globe.

That translates into consistent market-share dominance for most of its products. What’s more, even though a great proportion (about 45%) of Cummins’ sales come from the U.S. market, the huge spike in oil and gasoline prices has accelerated the U.S. migration into diesel engines, which are more- fuel efficient and have longer lives – and which is the company’s dominant product line.

Diesel engines already are in widespread use overseas, where Cummins derives the remaining 55% of its overall corporate revenue. The company is particularly strong in Europe (18% of sales), Asia/Australia (20%) and Mexico/Latin America (9%). Cummins can expect a big long-term growth boost from its power-generation business, where the company has a big advantage in such product areas as standby, mobile and distributed power generation. This business is growing quickly overseas, because of the inadequacies of the national electricity-distribution grids and the risks to interruption in many emerging economies.

With global growth across the world established solidly for the next two decades, and especially driven by the vast demands in China and India in power generation due to urbanization and industrialization, this business will be major growth driver for Cummins for years to come.

The company is very strong financially. Cummins has a market value of $13.4 billion. Last year it reported profits of $739 million on sales of $13.1 billion. Free cash flow was $1.23 billion. For all of 2008, Cummins is projecting that sales will advance 5% to $13.71 billion, while cash flow will increase 6% to $1.3 billion.

The input cost increase due to higher electricity and steel prices should pose no problem to Cummins’ margins, since its market dominance, cost leadership, and the scarcity of these products across the board gives this industrial heavyweight plenty of pricing power.

At Friday’s closing price of $65.95, Cummins’ shares were down 12% from their 52-week high of $75.09. But they’re 73% above their 12-month low of $38.11. However, there has been some recent weakness, induced by forced liquidations and unrelated factors to Cummins’ fundamentals. Ignore that as a negative: It actually only provides investors with an attractive buying opportunity. This opportunity is available to the very few, since the stock is under-covered by Wall Street, since it is boringly and consistently profitable.

Action to Take: BUY Cummins Inc. (CMI). Investors should rev up their purchases of this major maker of diesel engines and power-management systems.

[Editor’s Note: Horacio Marquez was working as a vice president of the Merrill Lynch Emerging Markets Fixed Income Group in 1994 when he correctly predicted that both Argentina and Mexico were headed for currency crises - cementing his reputation as an expert on both the emerging markets and on the nuances of global finance. Now Marquez brings that expertise to you with the newly created "Shadow Stock Trader" specialized trading service. To find out how to subscribe, please click here. "Buy, Sell or Hold" is a brand-new Money Morning feature that so far has covered Cisco Systems Inc. (CS), and ABB Ltd., ADR: ABB). Readers should feel free to write to us and suggest a stock they’d like to see analyzed.]

Source: Buy, Sell, or Hold: Cummins Inc.