Independent refiner Tesoro Corporation (TSO) came out with mixed fourth-quarter and full year 2011 results, reflecting a strong retail business unit and higher throughput, partially offset by disappointing refining margins.

The company reported loss per share of 89 cents, wider than the Zacks Consensus estimated loss of 66 cents. In the year-ago period, Tesoro had experienced adjusted loss of 13 cents.

For full-year 2011, the company earned $3.81 per share compared with a loss of 21 cents in the prior year. However, the reported results missed our earnings projection of $4.13.

The company reported revenue of $7,713.0 million for the three-month period, up 39.9% from the prior-year figure of $5,513.0 million. The result was 22.8% above our projection.

Tesoro generated revenues of $30,303 million in fiscal 2011, compared with $20,583 million in 2010. The fiscal result also surpassed the Zacks Consensus Estimate of $28,728 million.

Segmental Analysis

Refining: Tesoro’s Refining segment posted a quarterly operating loss of $123 million, against a profit of $128 million in the year-earlier quarter. The decline was due to low margins in California and weak crude oil spread.

Retail: The Retail unit earned $27 million during the three-month period, up from $11 million in the fourth quarter of 2010.

Throughput

Total refining throughput averaged 567 thousand barrels per day (MBbl/d) in the fourth quarter, compared to 505 MBbl/d in the year-ago quarter, aided by higher volumes in all regions.

California(Golden Eagle and Los Angeles) registered a year-over-year hike of 9.0% and the Pacific Northwest (Alaska and Washington) output shot up 36.3%. Throughput in the company’s Mid-Pacific (Hawaii) region increased 4.3%, while that of the Mid-Continent (North Dakota & Utah) improved marginally by 1.8%.

Refining Margins

Gross refining margin dropped 51.2% year over year to $6.02 per barrel. In terms of different regions, refining margin was down approximately 85.9% in California at $1.72 per barrel and 59.2% in the Pacific Northwest at $5.96 per barrel.

In the Mid-Pacific, gross refining margin was negative $4.33 per barrel versus a positive figure of $4.79 per barrel in fourth quarter 2010. The Mid-Continent region experienced 43.7% year-over-year growth in the margin at $21.38 per barrel.

Realized Costs & Prices

Manufacturing costs before depreciation and amortization decreased 8.5% from the year-earlier level to $5.03 per barrel, in keeping with Tesoro’s stated objectives of reducing operating costs and increasing throughput rates.

Total refined product sales during the quarter averaged 679 MBbl/d, up 15.9% year over year. The average price realized on product sales increased 22.7% year over year to $119.00 per barrel. Average cost per barrel was also up 30.0% from the fourth quarter of 2010 at $112.89 per barrel.

Capital Expenditure & Balance Sheet

In 2011, Tesoro’s total capital spending was $320 million, of which 82% was targeted toward the refining segment. Turnaround spending for the year was $109 million.

The company expects capital expenditure for 2012 to be around $670 million, together with turnaround spending of around $300 million.

As of December 31, 2011, Tesoro had cash on hand of $900 million and total debt of $1,701.0 million, representing a debt-to-capitalization ratio of 30%.

Acquisitions

During the quarter, Tesoro completed the acquisition of 49 Albertson’s Fuel Express stations from Supervalu Inc. (SVU). With total fuel sales of about 5 million barrels per day, the facilities are spread across Washington, Oregon, California, Nevada, Idaho, Utah and Wyoming.

Our Recommendation

San Antonio, Texas-based Tesoro enjoys the scale and diversification benefits afforded by its portfolio of seven refineries. We also appreciate the company’s solid long-term competitive position in the supply-constrained California market.

However, Tesoro remains exposed to the risk of dampened U.S. economic growth and weak product demand. Its lack of geographic diversification and excessive dependence on the West Coast market will further limit the ability to generate positive earnings surprises. Hence, we expect Tesoro shares to perform in line with the broader market and maintain our long-term Neutral recommendation.

Tesoro currently retains a Zacks #3 Rank (short-term Hold rating).

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