|Shares Out. (in M):||135||P/E||14.3x||8.6x|
|Market Cap (in $M):||6,612||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||3,916||EBIT||1,020||1,540|
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VIC Write-up: Tesoro (Long)
Tesoro is a U.S. based independent petroleum refiner and marketer, meaning it manufactures and sells transportation fuels. Tesoro’s refining segment, operating 7 refineries on the West Coast and Rocky Mountain regions, buys crude oil and refines it into transportation fuels. The refining segment also includes Tesoro’s logistics assets, which includes a 38% stake in Tesoro Logistics LP (NYSE: TLLP), a publicly traded MLP, for which Tesoro serves as the general partner. Refining can be disaggregated into 3 regions: California, Mid-Continent (N. Dakota & Utah), and Pacific Northwest (Washington & Alaska). Tesoro’s retail operating segment sells transportation fuels in 18 states through a network of 2,200 retail stations. A high proportion of the transportation fuels that its retail segment sells are purchased from Tesoro refineries.
Tesoro is a late stage turnaround with a strong balance sheet benefitting from a structural pivot in U.S. refinery profitability. When Tesoro’s CEO took over in late 2010 the company was levered at 2.4x and viewed as a low quality refiner due to its exposure to the West Coast where the economy was weak, regulation high, and geographically advantaged crudes out of reach. The new CEO, who has unlocked significant value since joining, recently closed the acquisition of several California assets from BP. Tesoro struck the deal for the cost of inventory and logistics assets received (both quickly converted to cash). In addition, Tesoro received retail assets worth ~$250MM and a refinery that should generate ~$1,000MM of normalized EBITDA (vs.$900MM consolidated avg. EBITDA between ’02 and ’11)!
Tesoro has been a highly volatile business trading at a low multiple (9x forward EPS / 4.5x EBITDA) whose earnings are undergoing a structural transformation due to the shale oil revolution in North America, which we expect to unfold similarly to the recent shale natural gas boom.
The above factors together should lead to significant earnings expansion and reduced earnings volatility, which could potentially re-rate the multiple higher as its holder base transitions from renters (high frequency traders focused on short term crude differentials) to owners. The market massively underestimates post-shale revolution earnings power, underappreciates the value of Tesoro’s retail and logistics businesses despite pure play comps (retail) and publicly traded equity (logistics MLP), and fails to recognize the value created by recent capital allocation. The CEO’s strong capital allocation means we don’t need a re-rating to get paid. He has shown himself eager to return capital to shareholders.
We believe Tesoro generates normalized EBITDA of >$2,500MM. Though we’re wary of using sum-of-the-parts valuation, as it can be more theoretical than practical, many sell-side analysts already disaggregate Retail and the MLP for valuation purposes, so we felt comfortable doing so as well. Not to mention, we expect the CEO to monetize the non-refining assets over time. We value the MLP LP stake at market, the MLP GP stake at 15x Consensus GP cash distribution, apply a 6.5x multiple to Tesoro’s retail EBITDA, apply a 4.5x multiple to its Refining EBITDA, and back out the MLP’s debt. We believe Tesoro is worth $90/share.
i. Refining capacity increases:
1) No new builds are planned.
2) AND it takes 2-4 years for a new build to come online.
ii. Refineries shift consumption materially toward light crudes and away from heavy crudes:
1) Our research suggests this is more difficult than many market observers believe.
2) As a result, we expect some heavy & medium crude imports to remain over the next 3 years despite greatly increased domestic production (primarily light).
iii. Saudi, Mexican, and Venezuelan producers allow displacement rather than react with a price response.
iv. Certain int’l producers (Saudi) allow their crudes to be displaced despite long term commercial arrangements. We believe 1.5-2.0MM Bbl/day (vs. 3.9MM Bbl/day imported in June) will not be backed out due to commercial arrangements.
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