Tesoro: (TSO: $77)
Recent Developments:
Sputtering stock price presents an opportunity. After a post-4Q EPS bounce from the low 80s to the high 80s, Tesoro shares have sputtered all the way back down, breaking through the $80 psychological threshold. While there has been a recent flurry of company-specific data points that could be perceived negatively, we do not see any of these as particularly material to the longer term investment thesis about why we like the stock. We continue to believe that closing the Western Refining deal will be a key fundamental and technical catalyst for the stock.
A flurry of tough data points recently. Tesoro shares have been weak over the past month, with factors like positive RINs (renewable identification number) headlines for merchant refiners (of which Tesoro is not one) and a soft Western Refining 4Q result hurting Tesoro’s stock price notably in early March. The past few weeks have been particularly tough, with (1) an Energy Index reweighting that caused very heavy volume in a few trading sessions. (2) California gasoline inventories that built on a spike in production, likely ahead of a sizeable electrical outage at Torrance in October; and, (3) headlines of a proposed 12 cents per gallon gasoline tax increase in California to help fund road repairs. While each is potentially negative, we are not overly concerned.
* Refiners have to pay a RIN tax. Just a fixed percentage of volume. This tax was putting small refiners out of business, which was a positive for Tesoro. But then came Trump and a new head of the EPA. Now "positive RIN" headlines is reference to discussion of doing away with the RIN tax or more likely reducing it materially – a bright outlook for small refiners to stop being clobbered by the RIN tax. The slight positive that Tesoro was experiencing from this regulatory matter is now normalizing.
We continue to believe in our positive long-term thesis. We recommended Tesoro, with the view that (1) financial performance was stable, (2) California fundamental risks do not present a death threat to the business, and (3) the Western Refining deal could lead to upside from both synergies and the MLP-value unlock potential, Western’s hidden MLP-like value. Our longer term thesis is unchanged, particularly with the Western Refining deal still on track to close in 2Q.
We see Tesoro as an attractive story in refining, with upside levers from Western Refining synergies and the possibility of corporate structure simplification. The acquisition of Western Refining adds a new element to the story, as it further diversifies Tesoro’s refining geographic mix and adds scale with a top-tier refining asset. It also adds an interesting Permian Basin growth angle to the midstream story. We think the recent stock weakness is overdone on perceived tough conditions in California.
Refinery margins move opposite the way you typically think of the Energy sector. So in the big selloff in Energy in recent years the refineries like Tesoro reported record performance. Warren Buffet of Berkshire Hathaway (BRK-B: $164) owns around 15% of peer refiner Phillips 66 (PSX: $76 , $39 billion market cap) at a premium to net asset value. Tesoro ($9 billion market cap) trades at a discount to net asset value. We think Tesoro is worth at least net asset value. Perhaps one day Buffet buys Tesoro through Phillips 66. Measures of Tesoro NAV are $100+.
BMR Take. We see substantial value in the shares with upside potential to net asset value north of $100. We note that recently Boston Partners and Point72 (two well-known investor groups) bought shares near current levels. Boston bought 3.2 million shares or 2.7%; Point72 bought 6.6 million shares or 5.6%.
We have a Target of $110 on the stock and a Sell Price of $75. Â