Refineries may be a good buy for the right investor

Tuesday, July 1st, 2014

Last week, the U.S. came up with new oil export rules that perhaps will allow us to export oil for the first time in 40 years. It was in the 1970s, during the oil embargo, when oil was going crazy. And that’s when the exportation of U.S. oil stopped.

Now there is talk that refineries will do it again, exporting what is known as condensate, an ultralight form of crude oil. This is a major revision in oil exporting.

When this news was released, oil refineries took a major hit downward. Some fell as much as 10 percent. The question is, are refineries now a good buy?

One thing investors remember is that this new ruling is not a done deal; it’s a potential deal. Also, if it doesn’t happen now, it will happen in the future as the U.S. continues to expand with new oil.

So with this new potential ruling, I wanted to see if now may be a good time buy into the refineries.

The refinery I looked at was Tesoro Corp (NYSE: TSO). The stock has a 52-week high of $62.89 with a 52-week low of $40.90; the current price hovers about $60 a share. The San Antonio-based company has a market cap of $7.9 billion.

Looking at the valuation ratios over the last 12 months, the current PE is 21.2 -- well below the industry’s 32.5. Price to sales for the company looks very good at .19, far below the industry at 3.17. Price to tangible book value checks in at 1.8, also a better buy than the industry average of 2.5.

Lastly, price to cash flow is the only valuation for the company that is above the industry average coming in at 8.0 -- about 10 percent higher than the industry average of 7.1.

The company does have a dividend yield of 1.7 percent and it used only 33.4 percent of its earnings over the last 12 months to pay that decent dividend. Sales for the company have grown at a rate of 33.3 percent year over year over the last 12 months -- more than double the industry average of 13.4.

Earnings per share over the same period, however, fell by 57 percent when the industry was increasing at a rate of 156 percent. These numbers look strange; with a growth of the industry, 156 percent must be from other things, not all from operations.

Looking at the earnings-per-share decline of 57 percent, I discovered on the income statement a large increase in interest expense operating, along with about $500 million in the recent quarter of other expense. This caused the income to decline but I cannot find a reason for the $500 million increase in other expense. If you're going to invest in this company, you want the answer to that question.

The financial strength of the company looks okay. The current ratio is currently 1.5, which beats the industry average of 1.0. Total debt to equity for to Tesoro stands at 66.6 -- slightly higher than the industry average of 58.4.

The management effectiveness looking at the return on common equity stands at 8.9 percent, below what I like to see normally, which is about 12 to 15 percent but still better than the industry average of 7.4 percent.

Due to the higher expenses I saw on the income statement, the net-profit margin for the company is low at 1.1 percent for the last 12 months compared with the industry average of 9.8 percent.

Receivable turnover for Tesoro for the last 12 months looks very good at 26.3, almost five times the industry average of 6.3. Inventory turnover also is very good at 16.8 times for the last 12 months while the industry comes in at 9.9 times over the same period.

Going out to the year ending Dec. 31, 2015, the mean of 16 analysts looked for earnings of $6.36 per share. There’s a wide range, with the low estimate being $4.50 and the high estimate of $9.50. This shows that maybe $6.36 may not be a strong number.

It is worth noting that the December 2015 estimate of $6.36 is roughly 18 percent higher than the $5.40 year ending December 2014. Using a forward PE of 16.5, which is the 40-year average, investors will get a target sell price of approximately $105. This would give investors a potential gain of 75 percent looking out to Dec. 31, 2015.

I also noticed, looking at the last four quarters’ earnings per share, that two of the quarters -- September 2013 and December 2013 -- the company missed the estimates, and for December 2013, it missed by 87 percent.

However, for March 2014 it surpasses the estimate by 65 percent. This also tells me that it’s very hard to count on the earnings estimates going forward; the company appears either to miss by a wide margin or beat by a wide margin. Overall, the company does look rather strong.

Tesoro has a peg ratio of 1.13, telling me that investors are not paying very much for the future growth of this company. Based on valuation ratios and the potential growth of this company, Tesoro may make sense for the right investors.


Do you have a question or a company you'd like me to take a look at? Email me at brent@wilseyassetmanagement.com!

Wilsey is president of Wilsey Asset Management and can be heard at 8 a.m. every Saturday on KFMB AM760. Information is provided by Reuters.

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