Tesoro - Shares Rise After It Buys BP's Refinery On The Cheap

| About: Tesoro Corporation (TSO)

Shares of Tesoro Coporation (TSO) rose 9.5% in Monday's trading session. The independent petroleum refiner and marketer announced the acquisition of BP's Southern California Refining and Marketing business.

The Details

Tesoro announced that it agreed to acquire BP's Southern California refining and marketing business. Tesoro will pay $1.175 billion, excluding the value of inventory at the time of closing. At today's prices, the inventory is valued at $1.3 billion, bringing the total deal value to $2.5 billion.

Tesoro expects to finance the deal in a combination of cash, debt and the proceeds of the sale of acquired logistics assets to Tesoro Logistics LP (TLLP). The proceeds of the sale of these assets is estimated at $1 billion. Tesoro expects earnings per share accretion to be roughly 24% in the first two years of operations.

Tesoro's CEO Greg Goff commented on the deal, "This transaction is a unique opportunity for Tesoro to combine the best aspects of two West Coast refining an marketing businesses resulting in a more efficient integrated refining, marketing and logistics system. We are well positioned to generate significant operational efficiencies, increase our ability to satisfy market demand and reduce stationary source air emissions."

The to be acquired BP's Carson refinery, has a capacity of 266,000 barrels per day. The refinery is located near Tesoro's Wilmington refinery which has a capacity of 97,000 barrels per day. Combining both facilities is expected to result in annual synergies of $250 million, after additional capital investments of $225 million.

Furthermore Tesoro becomes owner of 800 retail stations, which report average sales of 245,000 gallons per month. Included in the deal is furthermore the integrated logistics system which will be sold to Tesoro Logistics LP. The limited partnership will pay an estimated $1 billion in a staged acquisition of marine terminals, land storage terminals, pipelines and marketing assets.

The transaction is subject to the usual regulatory approval and expected to close before the mid of 2013.

Bargain Deal

All this means that Tesoro will pay a mere $175 million for a refinery with a capacity of 266,000 gallons per day. Furthermore it will own a retail network of 800 gas stations. It will also get a 51% ownership in a 400 megawatt co-generation facility, as well as a 350,000 metric ton coke calcining operation.

The only drawback is that Tesoro increases its geographic concentration in the state of California. It now has 60% of its refining capacity in that state, which is known for its tough environmental regulations.

BP (BP) is selling the refineries as part of a $38 billion divestment plan. The company is still paying to cover the costs from the Deepwater Horizon oil rig explosion and the consequent Gulf of Mexico oil spill. Over the last quarter, the company took a $2.7 billion charge against earnings on the refineries, indicating that Tesoro got a good deal.


Tesoro ended its second quarter with $1.3 billion in cash and equivalents. It operates with $1.7 billion in short and long term debt for a net debt position of roughly $400 million.

For the first six months of 2012, the company generated revenues of $15.9 billion. It net earned $455 million, or $3.14 per diluted share. This puts the company on track to report annual revenues of $30 billion. It could earn as much as $900 million, or $6.00 per share for the full year of 2012.

The deal will boost Tesoro's refining capacity by some 40% from 675,000 barrels per day to 941,000. Furthermore the number of retail gas stations will increase from 1,375 to 2,175.

The company did not provide more financial details. Assuming similar conversion rates, the company could report pro-forma revenues of $42 billion. Net earnings could rise to $1.3 billion, which excludes estimated annual synergies of $250 million. Including tax and limited financing costs, earnings could rise to $1.45 billion, or around $10 per share.

The market values the firm at $5.4 billion, or 0.13 times pro-forma revenues and 4 times annual pro-forma earnings. This compares to a valuation of 0.13 times for Valero (VLO) and 0.5 times for HollyFrontier (HFC). Both competitors trade at 10 and 6 times earnings, respectively.

Currently, Tesoro pays a quarterly dividend of $0.12 per share, for an annual dividend yield of 1.2%

Investment Thesis

Year to date, shares in Tesoro trade with gains of 66%. Shares traded as low as $22 in June of this year, and rose 70% in merely two months ever since. Currently trading around $39 per share, shares hit their highest levels since the beginning of 2008.

The favorable crude spread is boosting refining margins for US refiners. In recent months, refineries have seen a boost in profitability and valuation. While the crude spread played a major role, it has been beneficial that many US refineries have been closed down for unscheduled maintenance, recently.

Tesoro made a stellar deal and the market agrees. Investors send shares $3.37 higher in Monday's session, thereby boosting Tesoro's market valuation by almost $500 million. I personally think that management created a lot more value than Monday's price action reflects.

As a result of the cheap acquisition and the significant synergies to be achieved, I am a buyer of the shares in anticipation of new all time highs around $65 in the medium term.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in TSO over the next 72 hours.