Tesoro (TSO +0.00%) shares fell sharply late last month after the Commerce Department said it would allow exports of minimally processed condensates, a type of ultralight crude oil. The markets viewed the ruling as bearish for refiners since exporting large volumes of condensate would lead to a compression of the Brent-WTI spread, the chief determinant of U.S. refiners' profits.
While Tesoro has no control over federal regulators' decisions, the company has made major strides that should improve its financial performance over the next few years, assuming condensate export volumes are extremely limited. With that said, let's take a closer look at three key ways that Tesoro is improving shareholder value.
Growing access to cost-advantaged crudes
The first transformational undertaking Tesoro management undertook to improve shareholder value was boosting the company's access to cost-advantaged crudes, especially at its California and West Coast refineries, which account for more than 60% and roughly 85% of its refining capacity, respectively, after last year's purchase of BP's (BP 1.84%) 266,000-barrel-per-day Carson refinery near Los Angeles.
While West Coast margins have been weak in recent years, they should improve significantly over the next couple of years as Tesoro's extensive investments in crude offloading facilities and terminals improve the share of cost-advantaged crudes in its feedstock. By the end of next year, WTI should represent nearly 40% of the company's West Coast crude oil throughput, up from just 15% last year.
For instance, at its Kenai refinery, Tesoro believes it can potentially improve its access to cost-advantaged feedstocks such as Bakken and Cook Inlet oil from around a quarter currently to as much as two-thirds. At Martinez, it sees the potential to expand cost-advantaged crude feedstocks from 45% currently to up to 67%. And at its Los Angeles refinery, it believes it can potentially boost its feedstock from 15% California heavy currently to 50% California heavy and Bakken.
Creation of Tesoro Logistics
Another way Tesoro management has improved shareholder value is through the creation of Tesoro Logistics (TLLP +0.00%), a master limited partnership formed in 2011 to own, operate, develop, and acquire crude oil and refined products logistics assets. As a strategic partner in Tesoro's growth plan, Tesoro Logistics can leverage its low cost of capital to pursue organic expansion opportunities.
By doing so, TLLP is able to capture value from Tesoro's portfolio of logistics assets, while driving additional EBITDA and cash distributions through its stable, fee-based logistics model. And since many of Tesoro's assets will ultimately be dropped down to TLLP, its stake in the partnership should become more valuable over time, creating additional value for Tesoro shareholders.
As TLLP's EBITDA more than doubles from $156 million last year to an estimated $366 million in 2015, Tesoro's implied value of TLLP ownership is expected to surge from $10.47 per Tesoro share last year to an estimated $17.20 per share in 2015.
Share buybacks
In addition to paying a regular dividend, Tesoro has been returning cash to shareholders through an active share repurchase program that commenced in early 2012 and has a $1 billion authorization. As of the end of the first quarter of this year, the company had purchased $635 million worth of shares, with $100 million worth of shares purchased during the quarter.
In total, Tesoro has repurchased more than 14.5 million shares since it began the buyback program, representing roughly 10% of total outstanding shares in 2012. As the company completes its buyback program, earnings per share should improve further as the denominator (shares outstanding) falls.
Overall, the combination of these value-creating initiatives should deliver much stronger EBITDA and cash flows in the years ahead. Tesoro expects to improve its annual EBITDA over 2013 levels by $370-430 million this year and by $590-710 million in 2015, while generating an estimated $3 billion in free cash flow over the period 2014-2016, which can be returned to shareholders or used for expansion.
Investor takeaway
Tesoro has taken major steps to improve shareholder value over the past few years that should result in much stronger EBITDA and cash flow over the next few years. But investors should keep a close eye on any new developments regarding the condensate export ruling, as it could have a material impact on the company's earnings outlook and share price.
