Yesterday, Tesoro Hawaii Corp., a subsidiary of oil refiner and marketer Tesoro Corp. (TSO), won an aviation fuel supply contract worth approximately $186.7 million from the U.S. Defense Logistics Agency. 

The Pentagon said that Tesoro will provide fuel to the Defense Energy Support Center, which manages bulk fuel purchases on behalf of the U.S. Department of Defense. The contract, which ends on Oct 30, 2010, will require Tesoro to ship the fuel from its 94,000 barrel-per-day refinery in Kapolei, Hawaii .
We view this contract as a positive for Tesoro as this will bring much needed cash flows for the company in an otherwise gloomy economic environment. However, a combination of weak demand, excess production capacity, and narrowing crude quality spreads continue to weigh on Tesoro’s near-term margins, thereby squeezing its profits. The company’s lack of geographic diversification and heavy exposure to the weak California market has also become a major liability, in our view. Weighed down by these factors, the Texas-based marketer of petroleum products posted a second-quarter loss.

We see limited room for margin gains over the coming months, given the current gasoline and distillate inventory levels and the overall low utilization rate. As a result, in the medium- to long-term, we expect Tesoro shares to underperform the broader equity markets in general and the oil and gas group in particular.

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