When we compare two giant refineries, namely Tesoro (TSO) and Valero (VLO), we observe that the former is more attractive than the latter due to its low valuations, higher profit margins, better return on equity, and low dependence on debt. TSO is trading at attractive valuations, with an EV/EBITDA of 3.75x, at a discount when compared to its peer VLO's EV/EBITDA of 4x. Tesoro's five-year expected PEG ratio of 0.75 in comparison to 0.99 for Valero depicts that TSO's investors can buy growth cheaply. Therefore, we recommend investors to prefer Tesoro over Valero.
Tesoro should be preferred by investors due to its increasing crack spreads, higher capacity utilization, and increasing throughput. We believe the company will acquire BP's (BP) Carson refinery with its strong financial and legal position. This acquisition in Carson City will enable the company to achieve synergies because of its strategic location with TSO's West Coast refinery. Moreover, this acquisition will further increase the company's profitability through managing the carbon tax regulation in the California region.
Tesoro's gross and operating margins are 6% and 4%, slightly higher than Valero's margins of 4% and 3%, respectively. Tesoro has registered higher margins by achieving cost efficiencies in its California plant and has managed to bring down its direct manufacturing cost to $4.49/bbl in Q2. The company has been able to gain a cost advantage of feedstock in the Mid-Continent region. Moreover, TSO's lower debt-to-equity of 38%, when compared to VLO's D/E of 42%, reflects TSO's less financial leverage. TSO's higher ROE of 17%, in contrast to VLO's return to equity of 10%, makes TSO more attractive for investors. The company has announced to repurchase 500 million shares to further increase the return for its shareholders.
Gross Margin (TTM):
Operating Margin :
Tesoro's stock has shown a significant upside of 40% over the course of the last three months, when compared to Valero's price appreciation of 15%. TSO's 50-day and 200-day moving averages are $40 and $26, respectively. 90% of TSO's shares are held by institutions, in comparison to VLO's 79%. Tesoro's strong growth prospects, through bringing nine more retail stations into its retail network in the third quarter and adding 50 more sites till 2014 will enable the stock to show considerable upside. Both stocks have registered a downward trend in this month. The shares declined primarily because of a lower future guidance by Chevron (CVX) due to the blaze in its Richmond refinery. But we believe investors will soon realize that both these stocks have good future prospects and are trading at cheap valuations.
Qtrly Rev Growth (yoy):
PEG (5 yr expected)
Forward Price/Earnings (Dec 2013)
Valero is trading at an EV/EBITDA of 4x, at a premium when compared to Tesoro's EV/EBITDA of 3.75x. On the other hand, VLO is trading at a forward P/E of 6x, P/S of 0.12x, P/B of 0.96x and EV/Revenue of 0.16x, at a slight discount when compared with TSO. Despite Valero's attractive valuations on the aforementioned metrics, the most weight is given to the EV/ EBITDA factor due to the nature of the refinery industry. In the refinery industry, the focus is on generating more refinery margins, gross margins, operating margins and crack spread. Therefore, due to TSO's lower EV/EBITDA margins and lower PEG we think TSO is cheaper than VLO.