Tesoro: Despite 30% Correction, Fundamentals Remain Attractive

| About: Tesoro Corporation (TSO)

Shares of Tesoro (NYSE:TSO) hardly moved after the company presented itself at the Barclays CEO Energy-Power conference.

The company did not reveal any shocking facts during the presentation. Tesoro is making great progress on capital investment projects and the integration of the Carson acquisition. While 2013 is a transition year, solid operating cash flows driven by synergies and fewer capital expenditures should boost free cash flows in the coming years.

I continue to like the long-term appeal of the company, despite unfavorable refining margin developments in recent months, which triggered a 30% sell-off in recent months.

What's New

During the presentation CEO Goff announced that Tesoro's Golden Eagle refinery in California will receive its first dedicated train shipment of cheaper North Dakota crude. This would replace expensive Alaskan oil, boosting profit margins for the company. The company is still working on methods to take greater advantage of moving oil across the country, boosting earnings in the meantime.

With some 845,000 barrels of refinery capacity per day, getting crude oil a dollar cheaper in the refinery process results in huge additional earnings per year. Therefore Tesoro has engaged in multiple capital budgets allowing the company to have delivery options. This includes work at the Anacortes refinery in Washington. Another example is the $100 million rail-to-barge terminal at the port of Vancouver that will be built by the end of 2014, shipping oil to California and Alaska.

Other updates include the update of its Salt Lake City refinery, which should add $100 million per annum to the bottom line in terms of increased production and cheaper supplies.


Tesoro ended its second quarter with $428 million in cash and equivalents. The company operates with $3.37 billion in total debt, for a net debt position of close to $3.0 billion.

Revenues for the first six months of the year came in at $16.25 billion, up 13.3% on the year before. Net earnings have fallen by 28% to $320 million, resulting in earnings per share of $2.30

While Tesoro's operating results have always been really volatile, Tesoro could generate annual revenues between $35 and $40 billion. Full year earnings could come in between $500 and $600 million.

Trading around $46 per share, the market values Tesoro at $6.2 billion. This values equity in the firm at just 0.15 times annual revenues and 11-12 times annual earnings.

The quarterly dividend of $0.25 per share provides investors with an annual dividend yield of 2.2%.

Some Historical Perspective

Long-term holders in Tesoro have seen a few long year trends. Shares have risen from merely $4 in 2004 to highs in 2006. Following the severe 2008 recession, shares hit lows of around $8 in that year. Shares have steadily gained ground to rise to highs of $65 in May. After witnessing an almost 30% correction, shares are currently exchanging hands at $46 per share.

Between 2009 and 2012, Tesoro has nearly doubled its annual revenues to $33.0 billion over the past year. After reporting losses in 2009 and 2010, the company has reported solid earnings, peaking at $743 million last year.

Investment Thesis

After peaking at $65 per share in May, shares have seen a 30% correction on the back of unfavorable refining margin movements. Still, shares trade with very modest year to date gains of about 4%. Recently, Tesoro increased its quarterly dividend by 25% to $0.25 per quarter, boosting the dividend yield to a healthy 2.2%.

The highly integrated model by engaging in refining, marketing and logistics has created a player involved across the entire chain, and has fared the company well in recent years.

Yet 2013 remains a transition year. The integration of the mega-acquisition of the Carson refinery from BP (NYSE:BP) is finally taking place, as Tesoro is the owner of the assets for just three months now. Add to that a range of projects which require $0.5 billion in capital investments. These investments, coupled with slightly less favorable refining margins and a net $3.0 billion debt position following the Carson deal, make investors a bit worried.

The good news is that it is almost time to harvest for shareholders. The projects, acquisition of Carson and related synergies should boost production, lower input costs and improve efficiency. Coupled with lower capital expenditure requirements, free cash flows are seen above $1 billion in both 2014 and 2015, providing extremely attractive cash flow returns based on a current $6.2 billion equity valuation. As a matter of fact, Tesoro is upbeat it can surpass synergy estimates of a cumulative $1.25 billion through 2017 from the integration of Carson.

Back in May of this year I last took a look at Tesoro's prospects. I concluded that the company continued to create value as the Carson Deal neared approval. The timing of that article has been terrible given the price action in the months following, driven by narrowing refining margins.

Trading around 11-12 times this year's earnings, the good times will start next year. Annual synergies of $250 million per annum following the deal, and great internal rate of returns between 20 and over a 100% on an almost $500 million capital budget, should boost cash flows going forward.

I continue to hold on to my long position and might use these discounted levels to add to the position.

Disclosure: I am long TSO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.