Tesoro Corporation: Upside Potential Overlooked

Tesoro Corporation (TSO) engages in refining and marketing petroleum products in the United States. It operates in two segments, Refining and Retail. The Refining segment produces refined products, including gasoline and gasoline blendstocks, jet fuel, diesel fuel, and heavy fuel oils for sale to commercial customers in the western and mid-continental United States. This segment also manufactures liquefied petroleum gas, petroleum coke, and asphalt. As of December 31, 2007, the company operated 7 refineries with a combined capacity of approximately 658,000 barrels per day.

The Retail segment sells gasoline and diesel fuel through company-operated retail stations and third-party branded jobber/dealers in the western and mid-continental United States to wholesale and retail customers, as well as commercial end-users. Its retail-marketing system included 911 branded retail stations operated under the brands Tesoro, Shell, Mirastar, and USA Gasoline. The company was founded in 1968 as Tesoro Petroleum Corp and changed its name to Tesoro Corporation in November 2004. Tesoro Corporation is based in San Antonio, Texas.

Technical Analasyis

The chart above shows TSO for the last seven months (we wanted to show a year to date chart). The stock has been battered along with most of the other companies in the refining sector. Battered is a kind word to describe the pounding they have taken, actually. The 52-week high for TSO is $66 per share. The Relative Strength Index [RSI] and Moving Average Convergence / Divergence [MACD] stochastic lines are both rounding out at low levels, indicating a bounce, at least on a technical basis, could be coming.

TSO Fundamental Data

• Current Price: $19.32
• Shares Outstanding: 137.7 million
• Market Cap: $2.7 billion
• Forward Price / Earnings (avg. Est): 7.1x
• PE/G Ratio (5 Year Expected): 1..4x
• Price / Book: 0.9x

TSO has seen its revenues peaking at around $5.6 billion on a quarterly basis. For the June 2008 quarter, expectations are for the company to have registered approximately $5.8 billion, in line with $5.6 billion from last year in the same quarter. On a yearly basis, expectations are for about $22.8 billion in revenue, a growth of about 4% over last year's $22 billion. The impact to the firm's profitability has been much more pronounced - on a quarterly basis, there are actually losses showing up, with a March 2008 loss per share of $0.80 surprising everyone. the 2008 June quarter which will be released soon should show earnings of somewhere between a loss of $0.25 cents per share, or a gain of $0.28 per share. Kind of a wide range, but the 15 analysts who follow the company are not really sure of where the firm will come in.

On an annual basis, earnings in 2008 will probably be around $0..89, and this estimate has been slashed down from nearly $4.00 per share in EPS some 90 days ago. Now we know why the firm's shares have been decimated. For 2009, estimates are still up in the $3 per share range. We think the estimate for 2009 will change - that is one constant we can bank on. What we do know is that at $20 per share, the share price is discounting any possibility of earnings and profitability growth here. We like the upside potential from a pullback in crude prices and a possible expansion of the crack spread. There is also a meaningful short position in these shares, with 16 million shares short as of June 2008, or nearly 11% of the outstanding float of the company.

We like the small relative size of TSO as well - at under $5 billion the firm makes an outstanding acquisition candidate. At $21 per share of book value, we see an opportunity here for one of the majors to acquire TSO with hardly a flex of their muscles. TSO's balance sheet currently has a cash cushion of just over $41 million. The debt they carry though, amounts to over $2 billion. The firm's EBITDA is $930 million on a trailing twelve month basis. That gives us a solid comfort level that TSO and its cash flows are well managed.

Investment Recommendation

Our recommendation this week is to buy TSO stock at its present price of $19.32. We would also buy a November 2008 call spread in the $20 / $30 strike prices. We would look to acquire the TSO Nov $20 call for $3.00, and write the Nov $30 call for $0.80, for a net cost of $2..20 to this spread. We would look to sell this call spread at a level of $8.00 or higher between now and the future expiration, giving us a return of nearly four times the investment.

We've heard from a few of our readers who just want straight option buy recommendations, rather than spreads. For investors who do not wish to write the higher strike call, a direct purchase of the TSO November $20 call for $3.00 would be an alternative. We would look to sell that call at a level of $9.00 or higher.

Please note: Options trades all involve a high degree of risk and the potential to lose some or all of your investment. These recommendations are general in nature, and you should consult your own financial professional who is familiar with your situation as to the appropriateness of these trade ideas.

Disclosure: Analyst has no position in TSO stock or TSO options.

Comments

[secmaven]

At 16 and change today this reco was a bit premature.

[Marley]

In effect you are calling for a move to 28 or higher very quickly to get $8 on the spread which at most can be $10. In addition, math? Risk 2 to make 6 = 3x, not 4.

[Emthree]

"giving us a return of nearly four times the investment"
Daniel, you have made this incorrect statement in several other posts. As Marley points out, risk 2 to make 6 is ** three times the investment ** (not four). I wonder why you continually make the same error in your posts ?