1 Undervalued Refiner Could Fatten Your Wallet

The refining business is a highly cyclical one, with profits determined largely by commodity prices -- specifically, by the price difference between domestic crude oil benchmarks and Brent, the global crude oil benchmark.

While many U.S. refiners have reaped windfall profits over the past few years, thanks to historically low domestic benchmark crude prices, Tesoro (NYSE: TSO  ) hasn't been able to fully participate in this highly favorable refining environment.

But that's about to change as the company's extensive investments in crude-by-rail infrastructure significantly boost its access to cost-advantaged crudes, providing a big uplift to margins, EBITDA, and cash flows that could meaningfully boost its share price.

Photo credit: Wikimedia Commons

Tesoro's locational disadvantage
One of the main reasons why Tesoro hasn't benefited from wide U.S. crude oil differentials as much as its peers is because the company's refining footprint is mainly concentrated on the West Coast, especially since it acquired BP's (NYSE: BP  ) 266,000-barrel-per-day Carson refinery near Los Angeles back in mid-2013.

Of the company's roughly 850 thousand barrel per day (MBD) refining capacity, about 85%, or 720 MBD, is located on the West Coast, with California alone accounting for more than 60%, or roughly 530 MBD, of total refining capacity. This West Coast concentration has put the company at a disadvantage to many of its peers due to limited access to cost-advantaged crudes and, therefore, weaker margins. Tesoro's gross refining margins in California and the Pacific Northwest averaged just $8.47 and $10.33 in 2013, as compared to its overall gross refining margin that averaged $11.19 per barrel last year.

By contrast, Midcontinent-focused refiners have enjoyed much stronger margins thanks to their preferential access to cheap inland crude. For instance, Hollyfrontier (NYSE: HFC  ) , whose three Midcontinent refineries account for more than 70% of its total refining capacity, enjoyed gross margins well in excess of $20 per produced barrel over the past few years, though margins have compressed significantly in recent quarters.

Gulf Coast-focused refiners like Marathon Petroleum Corporation (NYSE: MPC  ) and Valero (NYSE: VLO  ) also saw relatively weak margins compared to Midcontinent refiners last year. Valero, whose Gulf Coast refineries account for 55% of total refining capacity, had an average refining throughput margin per barrel averaged $9.69 in 2013, while Marathon, whose Gulf Coast operations represent more than 60% of total capacity, posted an average gross refining margin of $13.24 per barrel last year.

Headwinds turning to tailwinds
But Tesoro's relative disadvantage should improve sharply as the company's heavy investments in projects designed to give it greater access to cost-advantaged crudes come to fruition. For instance, it started up a crude offloading facility at its 120,000 bpd refinery in Anacortes, Washington, back in 2012, which is now processing some 50,000 barrels per day of cost-advantaged Bakken crude, nearly half of its total capacity.

Tesoro is also developing a rail-to-marine crude transloading terminal in Washington state that will allow it to ship discounted crudes via rail to its West Coast refineries. Though the project has been delayed due to permitting requirements, the company expects to begin construction by late this year or early 2015, with initial volumes expected to begin moving by mid-2015.

Overall, Tesoro expects to boost its volumes of discounted crude to the West Coast by more than 300 MBD by next year. This means that WTI will account for nearly 40% of its total West Coast crude oil throughput by year-end 2015, up from 15% as of the third quarter of 2013, providing a meaningful uplift to margins and returns.

Strong EBITDA and cash flow growth on the way
As Tesoro improves its base business, grows logistics, realizes synergies from the California acquisition, and improves its gross margins, its EBITDA and cash flows should grow sharply. The company is forecasting an annual EBITDA improvement over 2013 levels of $370-430 million this year and $590-710 million in 2015, while total free cash flow generation over the period 2014-2016 is expected to total roughly $3 billion, allowing it to pursue additional growth opportunities and return cash to shareholders.

Investor takeaway
Tesoro's heavy investments in offloading facilities should greatly boost its access to cost-advantaged crudes from the Midcontinent and Canada, leading to a sharp improvement in its financial performance. Despite the company's exceptional prospects for earnings and cash flow growth, it trades at a slight discount to peers -- a discrepancy that, in my view, makes it one of the most compelling opportunities in the U.S. refining sector.

Will this stock be your next multi-bagger?

While Tesoro's improving fundamentals promise significant upside, there's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.


Read/Post Comments (1) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 20, 2014, at 6:52 PM, antiquelindy wrote:

    Your article is fine, but comparing Tesoro to Valero, I would select Valero as the undervalued refinery .............Valero P/E = 10.75..Earnings = $5.33....Div. = $1.00....Price per share = $57.36........................................................Tesoro P/E =21.12.....Earnings = $2.91.....Div. = $1.00......Price per share = $61.45. The rail cars and other items discussed sounds same as Valero + the possibly of Keystone pipeline should benefit Valero

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 3000901, ~/Articles/ArticleHandler.aspx, 12/19/2014 10:10:53 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 17,752.88 -25.27 -0.14%
S&P 500 2,066.78 5.55 0.27%
NASD 4,740.70 -7.70 -0.16%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

12/19/2014 9:54 AM
BP $38.77 Up +0.45 +1.17%
BP p.l.c. (ADR) CAPS Rating: ****
HFC $37.27 Up +0.57 +1.56%
HollyFrontier Corp… CAPS Rating: ****
MPC $86.21 Up +2.18 +2.59%
Marathon Petroleum CAPS Rating: ****
TSO $73.19 Up +1.81 +2.53%
Tesoro Corp CAPS Rating: ****
VLO $48.14 Up +1.07 +2.27%
Valero Energy Corp CAPS Rating: ****

Advertisement