Tesoro Corporation (NYSE:TSO) is a $5.7 billion refining and marketing company with assets in the West Coast and Rocky Mountain regions of the US. Tesoro has several characteristics we like in an investment: 1) significant hidden value in high-multiple assets like retail, pipelines, and General Partner interests; 2) impending transactions/projects that are underappreciated by the market; and 3) a shareholder-friendly management team focused on creating value. While it is perhaps unusual to invest in a company following a quarter (Q3 2012) in which the stock appreciated by ~68%, we believe Tesoro remains misunderstood by the market; as evidence, current sell-side analyst price targets range from $35 to $84!
Tesoro trades at one of the lowest multiples (2.6x) in the refining sector on 2012 EBITDA, despite the fact that refining peers are currently “over-earning” due to wide LLS-WTI spreads. In contrast, the bulk of Tesoro’s portfolio (West Coast) is earning margins consistent with historical levels, while the company’s two Mid-Continent assets (Mandan, ND and Salt Lake City, UT) should continue to experience wide crude discounts given their niche positions and distance from coastal markets. Contrary to our expectations for other refiners, we see Tesoro’s earnings rising in the coming years, notwithstanding shrinking WTI-LLS spreads.
Part of this earnings growth will come from the pending acquisition of BP’s 266kbpd Carson refinery. 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 additional ~$250 million in annual synergies. We expect this deal to be approved by regulators in the first half of 2013. Finally, Tesoro is one of the last refining companies to begin returning meaningful amounts of cash to shareholders. The company should continue to repurchase significant amounts of its undervalued stock in the near-term and subsequently use a combination of regular and special dividends to distribute excess cash to shareholders.
Using conservative assumptions, we see Tesoro generating about $9 per share in annual excess FCF on a normalized basis and our expectation is that shares can double from the current price of $40. We believe the Q3 story was only the beginning, and are happy to own Tesoro for its next few chapters.
From Daniel Loeb's Third Point fourth quarter investor letter.