A Potential Rally for This US Refiner
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In the fourth quarter letter to investors, Dan Loeb, who is currently managing more than $10 billion, revealed a long position in Tesoro Corporation (NYSE: TSO). This investment could be considered to be his play on US refiners. He believed that this refining and marketing company was quite misunderstood by the market. Let’s dig deeper to see if we should follow Dan Loeb into Tesoro.
Tesoro is operating via two main business segments: refining and selling transportation fuels. It had 7 refineries in the US with a total capacity of around 665,000 BOE per day, refining crude oil, gasoline, jet fuel, liquefied petroleum gas, etc. Its retail operation, with more than 1,200 stations under several brands, including Tesoro, Shell, and USA Gasoline, sells transportation fuel and convenience products in around 18 states. The majority of Tesoro’s revenue, $29 billion, was from the refining operation, accounting for more than 95.7% of the total revenue. In 2011, the refining segment contributed nearly $1.18 billion to the company’s operating income, while the retail segment only generated around $89 million in operating profit.
A Sweet Year for US Refiners
In the past twelve months US refiners have enjoyed a significant rally. It was thought that the boom in the US refining sector was due to the low US crude price, which resulted from the increase in shale and tight oil production in the US and Canada. The record-high WTI/Brent spread has let refiners access WTI-price inputs to produce higher Brent-priced refined products. Tesoro, HollyFrontier (NYSE: HFC), and Valero Energy (NYSE: VLO) all joined the bull.
Over a year Tesoro experienced the highest rise, nearly 84%, whereas Holly Frontier and Valero share prices have increased 67% and 62.5%, respectively.
3 Things Dan Loeb Loves About Tesoro
Even after the significant share price increase, Dan Loeb still decided to get into Tesoro as he thought the market still significantly undervalued the company. He pointed out three main characteristics that he liked about this refiner. First, Tesoro possessed huge hidden value in several assets including pipelines, retail, and General Partner interests, which should receive high multiples valuation. Second, the market was undervaluing the company’s upcoming transactions/projects. Third, Tesoro’s management was shareholder-friendly and they concentrated on creating value for both shareholders and the company. He also mentioned that the sell side analysts set the price target for Tesoro in the range of $35 to $84 per share. Dan Loeb believed that even with the narrowing WTI-Brent spreads, Tesoro earnings are set to increase in the coming years, partly due to its Carson refinery purchase from BP.
A Good Refining Business Acquisition
The $1.175 billion acquisition of BP’s Carson assets has been viewed quite positively for Tesoro, as it would strengthen the company’s West Coast business with increasing distillate yields, lower refining and distribution costs. Tesoro expected to achieve the annual synergies of $250 million from the deal. In 2013, the post acquisition EBITDA was estimated to be $2.13 billion, a growth of 29%. The post-deal net income in 2013 would be $842 million, with the EPS of $5.99. Dan Loeb was quite excited about this deal; he wrote in the letter, “After deducting working capital and $1.125 billion of logistics and retail value, Tesoro paid about $50 million for a refinery that is estimated to generate $375 million of EBITDA and yield an addition $250 million in annual synergies.”
In terms of operating performance, HollyFrontier seems to be the best among the three. Over the past 12 months, HollyFrontier had the highest net margin of 7.83% and the highest ROIC of 23.28%. Valero's margin and ROIC were the lowest, of 0.8% and 4.6% respectively, whereas Tesoro had 1.83% in net margin and 10.4% in ROIC. All three refiners mentioned above are priced at quite low valuations. HollyFrontier is the cheapest, with only 2.77x EV/EBITDA. Valero seems to be the most expensive one among the three, with 4.54x EV/EBITDA, while Tesoro is valued at 4.05x EV multiples.
Potential Rally Ahead?
Dan Loeb conservatively estimated that Tesoro would generate around $9 per share in annual normalized excess FCF. He expected that its shares are likely to reach $80. Indeed, Tesoro is currently cheap compared to the assets it owns. In addition, the recent Carson asset acquisition would further boost Tesoro's share price in the near term.
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