In an earlier article, I argued that Valero (VLO) trades substantially below intrinsic value. The stock has gone down since then and, consequentially, I see very little downside at this point. The stock is incredibly cheap and management is committed to improving the balance sheet while holding off on acquisitions. With the best-in-class production power, more aggressive capital allocation policy, and solid connections to key export areas, I believe that the company is skewed considerably more towards reward than risk. I similarly believe that competitor Tesoro Corporation (TSO) is undervalued, as it is improving throughput while decreasing variable costs.
From a multiples perspective, both stocks appear cheap. Valero trades at only a respective 5.6x and 5.3x past and forward earnings, while Tesoro trades at a respective 4.9x and 5.3x past and forward earnings. Analysts currently rate shares of the former a "buy" and those of the latter a "hold". While I agree that shares of Valero stand to appreciate more than those of Tesoro, I rate both companies more of a "buy".
At the shareholder/analyst call, Tesoro's CEO, Greg Goff, noted
2011 has actually been a very successful year for Tesoro, and we're very proud of things that we have accomplished. We really -- we believe that with the changes in management back in 2010, we really embarked upon a very ambitious plan to really fundamentally and significantly improve the business. And we thought when we put this plan together back in 2010 that it would take us about 3 years to really achieve all the things that we set out to do, and 2011 was really the first year where we really got things going, and we'll share some of the accomplishments that we think we have accrued [ph] today on this journey to really significantly improve the performance of the business. And really, this improvement, it's really characterized by a lot of things. I mean, our focus, like Louie said, on both personal and process safety, driving performance in our overall environmental performance to really be able to go in and get -- develop a better cost structure for the business, drive improvements in the reliability around our assets, really being able to exercise a lot of capital discipline and take our free cash flow and with our stated intent to reinvest it in the business to generate additional earnings as we go forward, and then really to drive a high level of integration between refining a market.
Note: For whatever its worth, the word "really" was used 134 times during the call… really.
Tesoro is benefiting from higher diesel crack spreads that have meaningfully expanded margins; more than what the market appreciates. At the same time, the company has been successful in expanding throughput and trimming costs. During the third quarter, the company had gross margins 38% above the Industry Index, largely due to the fact that the firm operates refineries with discounted crudes. Refinery intake came in at around 609 mbd, as an average, while capital utilization was the highest it has been in over three years. Average manufacturing costs also fell 26% from last year - the lowest in several years.
Consensus estimates for Tesoro's EPS are that it will turn positive in 2011 at $5.63 and then decline by 25.8% and 4.5% in the following two years. Assuming a multiple of 7.5x and a conservative 2012 EPS estimate of $4.10, the rough intrinsic value of the stock is $30.75. This implies 35.6% upside and, in my view, justifies an entry.
Ditto for Valero, despite its entry into low growth Europe. The company is successfully improving its balance sheet and remains committed to not taking any dilutive action to EPS. Consensus estimates for its EPS are that it will grow by 193.8% to $4.76, decrease by 14.3% in 2012, and then increase by 0.5% in 2013. Of the 10 revisions to estimates, 8 have gone down for a net change of -1.8%. Even still, assuming a multiple of 7.5x and a conservative 2012 EPS estimate of $4.01, the rough intrinsic value of the stock is $33.08. This implies 50% upside and makes it one of the most discounted energy players right now.