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Shares of Tesoro (TSO) have seen some volatility in recent days. Last week Wednesday, the refiner and marketer of transportation fuels reported its third quarter results. Shareholders were not impressed last week, but shares rose almost 10% in Monday's and Tuesday's trading session. Tightness in the Californian gasoline market and delivery problems in the Northeast after the superstorm Sandy are causing a lot of volatility for refiner stocks.

Third Quarter Results

Tesoro reported third quarter revenues of $8.78 billion, up 8.3% on the year. Revenues beat analysts consensus of $8.51 billion.

The company reported net income of $273 million, or $1.92 per diluted share. This compares to last year's earnings of $345 million, or $2.39 per diluted share. The company took a $0.13 charge related to the early redemption of $1.2 billion in notes outstanding.

Tesoro furthermore experienced some crude oil delivery disruptions, maintenance in California, and incentive compensation totaling $65 million, or $0.45 per diluted share. Adjusted for these charges, earnings came in at $2.37 per diluted share. On average, analysts expected Tesoro to report earnings of $2.29 per share.

CEO Greg Goff commented on the results, "Our solid operating performance and high refinery utilization allowed us to capture attractive market conditions. We made significant progress on our high-return capital program, executed our second asset sale to TLLP and announced the transformation acquisition of BP's Southern California refining and marketing business."

Segmental Information

Tesoro's refining operating income rose 1.7% to $610 million. Total throughput volumes rose 2.7% to 626,000 barrels per day. Gross refining margins fell eleven cents to $18.32 per barrel, while manufacturing costs fell fifteen cents to $4.42 per barrel.

The Californian region reported a 5.3% increase in throughput to 260,000 barrels per day. Gross refining margins fell to $12.11 per barrel, with manufacturing costs falling to $5.97 per barrel.

The Pacific & Northwest region reported a 4.1% decrease in throughput to 162,000 barrels per day. Gross refining margins rose to $17.39 per barrel, with manufacturing costs increasing to $3.78 per barrel.

The refinery on Hawaii reported a 5.4% increase in throughput to 78,000 barrels per day. Refining margins fell to $8.92 per barrels, while manufacturing costs fell to a mere $2.68 per barrel.

Mid-continent production rose 5.9% to 126,000 barrels per day. Refining margins rose to an incredible $38.11 per barrel, with manufacturing costs falling to a mere $3.12 per barrel.

Valuation

Tesoro ended its third quarter with $1.4 billion in cash and equivalents. The company operates with $1.6 billion in short and long term debt, for a modest net debt position.

For the first nine months of 2012, Tesoro generated $24.7 billion in sales. Earnings applicable to shareholders came in at $716 million, or $5.06 per diluted share. At this rate, the company is on track to earn $1 billion for the full year, on sales of $33 billion.

The market currently values Tesoro at $5.0 billion. This values the operating assets of Tesoro at $4.8 billion. As such, the operating assets are valued at 0.15 times annual revenues and roughly 5 times annual earnings.

Tesoro's board of directors raised its quarterly dividend by 25% to $0.15 per share, for an annual dividend yield of 1.7%.

Investment Thesis

Year to date, shares of Tesoro have risen some 52%. Shares rose from $22 in January to $30 in March, before falling back to $22 in May. Shares doubled from that point in time on the back of a favorable environment for refiners and the buyout of BP's refinery. Shares fell some 20% in recent weeks on concerns about the deal with BP. As a result of the deal, Tesoro will control 25% of California's refining capacity, in a market with traditionally high gasoline prices.

Over the past five years, shares are still down some 40%. Shares peaked at $65 in 2008 and fell back to lows of $10 later that year. Between 2008 and 2012, Tesoro has grown its annual revenues from $28.4 billion to an expected $33 billion this year. The company reported a net profit of $278 million in 2008, followed by modest losses in 2009 and 2010, before reporting a large profit this year.

In August of this year, Tesoro announced the acquisition of BP's Southern California refinery. The deal boosted Tesoro's refining capacity by some 40% to 941,000 barrels per day. The deal has recently received some scrutiny after high Californian gasoline prices caused outrage among consumers. The deal is still pending regulatory approval.

I think the risk-reward ratio is appealing given the strong balance sheet, strong earnings and the continued favorable business environment. I remain a holder of the shares.

Source: Tesoro - Earnings Disappoint On One-Time Charges