We are maintaining a Neutral recommendation on Tesoro Corporation (TSO), based on the company’s strategic initiatives, acquisitions and investment programs, partially offset by the volatility of the refining business and weak product demand.
San Antonio, Texas-based Tesoro is an independent refiner and marketer of refined petroleum products in the western U.S. The company operates in two segments: Refining (accounted for 93% of the company’s total 2011 operating income) and Retail (7%).
In the recently released fourth-quarter 2011 results, Tesoro presented a mixed performance on the back of a strong retail business unit and higher throughput, partially offset by disappointing refining margins. The company reported quarterly loss per share of 89 cents, wider than the Zacks Consensus Estimate of 66 cents loss per share. However, revenue of $7,713.0 million was 22.8% above our projection.
Looking ahead, we remain concerned about the lackluster economic growth in the U.S. that will likely limit the upside potential of the domestic refiners. We believe that high unemployment in California – Tesoro’s core business region – and excess refining capacity in the U.S. will continue to weigh on the company’s margins.
Additionally, in terms of geographic diversification, Tesoro’s lack of exposure to the other refining regions in the country weakens its competitive positioning. The company’s West Coast centric operating footprint and heavy dependence on the weak California market act as major liabilities.
However, negating these unfavorable aspects of the stock is Tesoro’s strategic actions that are expected to improve its performance and competitiveness in a cost-effective manner and boost stock valuation.
These initiatives include economies of scale for crude purchases in California, the commissioning of the delayed coker at Golden Eagle, improved electricity reliability and control modernization at Hawaii, and increased sour crude oil processing capacity at Anacortes. Additionally, management is in the process of disposing assets that do not fit the company’s long-term development planning.
Tesoro also plans to invest about $180 million for the expansion of crude oil throughput capacity at the Salt Lake City, Utah refinery. We believe this step highlights management’s efforts to capitalize on high-return short payback projects that will enable the company to reap higher and better profits.
In an attempt to expand network in the domestic market, Tesoro acquired 49 Albertson’s Fuel Express stations from Supervalu Inc (SVU), spreading across Washington, Oregon, California, Nevada, Idaho, Utah and Wyoming.
Hence, considering these factors, we expect Tesoro to perform in line with the broader market that gives investors a reason to hold on to the stock. Tesoro currently retains a Zacks #3 Rank (short-term Hold rating).
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