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Krause Fund Research Fall 2016
Energy Recommendation: HOLD Analysts
David Ballard [email protected]
Nico Chaidez [email protected]
Kevin Dochterty [email protected]
Cory Paterson [email protected]
Company Overview Tesoro Corp. operates as an independent oil refinery, marketer, and logistics company. Headquartered in San Antonio Texas, Tesoro operates mainly throughout the western United States. The company currently owns 7 refineries and sells refined gasoline and diesel fuel to 2,400 retail locations, 595 of which they own.i Through their subsidiary Tesoro Logistics (TLLP), they deal with gathering, processing, and transportation of oil. The company currently has over 6,000 employees worldwide Stock Performance Highlights 52-week High $67.80 52-week Low $119.67 Beta Value 1.252 Average Daily Volume 2.15 M Share Highlights Market Capitalization $16.078 B Shares Outstanding 116.87 M Book Value per share $46.53 EPS (2015) $12.50 Forward P/E Ratio 14.27 Dividend Yield 2.5% Dividend Payout Ratio 34.69% Company Performance Highlights ROA 5.49% ROE 10.36% Sales $28.64 B Financial Ratios Current Ratio 1.90 Debt to Equity 57.13%ii
Tesoro Corp. (NYSE: TSO)
November 11, 2016
Current Price $84.61 Target Price $90-97
TSO exhibits potential but marked by uncertainty
Tesoro’s refining segment indicates competitive advantage but overall company performance is susceptible to volatility of crude oil prices. Management has indicated the company’s intent to increase the marketing and logistics portion of their operations. The integration will help the company stabilize their earnings as they can focus on operational efficiency to drive value-driven growth. Tesoro successfully reduced their inventory in the 3rd quarter in an effort to raise cash. The company is looking to grow inorganically if attractive assets present themselves on the market. The future of TSO is highly dependent on ROIC changes as they look to make these acquisitions and grow organically as well. Tesoro is heavily indebted to compared to industry peers. The $4.6 billion of debt on their balance sheet could impede their ability to pay dividends to stockholders and make them more vulnerable to changes in economic conditions Potential change in industry regulations loom with Trump presidential victory. Refineries surged in wake of election as Trump has indicated his disapproval of costly fuel regulations, namely RINs. iii
One Year Stock Performance
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Economic Outlook
Demand Demand for crude oil is driven by global economic growth since it is the basic fuel for transportation and power source for countless industries. The chart below measures the consumption of all liquid fuels against world GDP growth and WTI prices. It is evident that changes in real GDP has a direct effect on oil demand and higher GDP growth has historically coincided with higher oil consumption.
vEIA.gov This demand is driven by OECD countries which tend to be primarily service based and non-OECD countries which tend to have more of their economies in manufacturing industries. Historically OECD countries have consumed more oil, but between 2000 and 2010 OECD demand actually declined whereas consumption by non-OECD increased 40% over that same time period.vi This soar in demand was spurred mainly by countries such as China, India and Saudi Arabia due to their structural conditions. According to the EIA, much of the world increase in energy demand will continue to derive from non-OECD countries where stronger economic growth and expanding countries will outpace their peers. Demand from non-OECD countries is expected to rise by 71% through 2040, in contrast to 18% from slower-growing more mature energy consuming OECD countries during the same period.vii
viii-EIA.gov
Looking forward, China’s GDP growth rates have been forecasted at 6.60% in 2017 and trend around 5.80% growth in 2020.ix Although China’s population continues to increase we believe the 5.8% growth is slightly overinflated due to depressed global trade, productivity and wages. A slower growth rate than normal for China indicates sluggish demand which contributed to falling oil prices in 2014. Future demand will have to stem from an unexpected pickup in the China economy or from another prospering non-OECD country. India’s GDP growth rates have been forecasted at 7.3% in 2017 and trend around 7.2% in 2020.x We agree these estimates are in line provided India’s GDP composition differs from China having only 24.2% made up by manufacturing and majority made up by services at 57.9%.xi In contrast, OECD growth rates have been forecasted at 2.07% in 2017 and the US GDP growth rate have been forecasted at 2.21%.xii We believe these growth rates are justifiable and will continue at the modest growth due to global economic uncertainty and their mature economic conditions. Higher realized growth rates in both country groups would result in climbing oil prices assuming supply is constant. Brent prices are expected to average $51 in 2017 with West Texas Intermediate averaging about $1 less than Brent prices.xiii Since expected GDP growth is modest and expected supply from OPEC is uncertain we agree with EIA’s forecasts and estimate 2018 and 2019 barrel prices to be around $55-$60, respectively. We do not expect oil to near its past high prices in the $100s throughout 2020. Supply Total world oil production is derived from two distinct groups: OPEC and non-OPEC. Since 2014 oil supply by both groups have greatly outpaced global demand causing oil prices to fall from $100/barrel to $35/barrel to its current price of $43.41/barrel. The main contributors to the supply flood have been Saudi Arabia, U.S, Russia, and Iran. Global oil supplies raised by 0.6 mbpd in September to 97.2 mbpd due to higher Russia and Kazakh flows and OPEC crude record highs. OPEC has a responsibility to coordinate oil production policies to restore market stability. OPEC has agreed to limit the groups output to a range of 32.5 million to 33 million barrels a day compared with 33.64 million in October. Details including individual country targets are expected to be set during the scheduled meeting on Nov 30th. Libya, Nigeria and Iran are said to be exempt from any supply cuts. Due to the fact that the targets of the supply cuts have not been finalized however, there is the risk of these agreements falling through, or being altered.
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xiv Although OPEC has set Limits or quotas in the past, the countries within it have continuously produced higher. This calls into question the reliability and authenticity of limits that they are currently trying to set or may set in the future.
xv Production from non-OPEC countries surged by 0.5 mbpd in September as Russian crude increased to a post-soviet high and Kazakh volumes recovered from maintenance. However, September production was down by 0.9 mbpd compared to the previous year due to sharp declines in the US and China. Non-OPEC supply is forecasted to decline by 0.9 mad in 2016 before rebounding back up by 0.4 mbd in 2017. xvi
xvii The Energy Industry has significant impacts on OPEC and non-OPEC countries as it can account for large portions of total revenue. This causes countries to be largely dependent on the sector and creates implications when prices drop and supplies must decrease.
Some analysts forecast oil prices to be below $50 a barrel leading into the year 2017. We expect oil to hover around the $45/barrel mark for the next 6-8 months, but remain optimistic prices will rise above the $50 threshold in the next 2-3 years with current OPEC talks and slowing US production. Global oil exploration is an important factor for future supply because once resources are found it takes years for the new oil supplies to actually become available to the public. What is worrisome for global supply is that explorations of conventional oil are the lowest they’ve been since 1947. This is a reflection of falling oil prices, which led to companies cutting this expense to 40 billion this year from about 100 billion in 2014. As oil prices have remained relatively low these cuts in expenses are expected to continue in the short term. Oil Inventories The current state of the oil industry relies heavily on the inventory levels of oil. Companies are becoming more efficient in the searching, recovery, and production process of oil. With advancements in technology, and Schlumberger’s continued efficiency, supply comes to outpace demand. If oil prices are high, companies will spend more on drilling. When companies increase their spending, the rig count shoots up. Their current rig count is decreasing to levels not seen since the 90s. The last time there was a dip in the rig count equivalent to recent trends was the recession of 2008.
Baker Hughes Rig Count
2016 data showed 1,567 rigs around the world, a sharp decline from 2014 and 2015 at 3,578 and 2,337.xviii We believe the rig count will stabilize at its current count. Inventories continue to be high, which decreases rig count, with continued unsuccessful negotiations of OPEC. The daily rates to operate rigs also play into inventory levels. A decrease in day rates mean there’s less of a market demand for oil. There’s a current decreasing trend for day rates and utilization with drill ships, semisubmersibles, and jack ups. The chart below shows the day rates along with the utilization rate for the world for the past three years.
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Industry Analysis
HIS Marketxix
The current day rate for a Drillship (4,000’+) is $477,000. The day rates have slowly been declining but have stabilized in 2016. Trends for Semisubmersibles and Backups mirror that of the worldwide Drillship chart except with prices ranging from around $350,000 and $80,000.xx Inventory levels have had high volatility recently with a large drop of 14.5 million barrels on September 8th, potentially due to the hurricane conditions off the east coast. As well as a large increase of 14.4 million barrels in late on November 2nd as OPEC countries have not limited or cut their output.xxi The chart below shows the week over week change for crude oil inventories.
Energy Information System Federal Funds and Interest Rates The federal funds, which currently sits at .50%, is a driver of interest rates throughout the economy. A spike in interest has seemed loomed for some time now, and there is a probability we will see an increase in December as the Federal Reserve Bank convenes. All sectors of the economy would be impacted, as borrowing costs would rise accordingly with the rate. The hike in rates would significantly impact the energy sector, as firms tend to be highly leveraged in the industry. Looking at the historical value of interest rates, it seems extremely likely that we will see an increase in the next year, if not sooner.
xxii Interest rates are also a market driver in the Energy sector because of the inverse relationship that dollar value and oil and commodity prices have. Over the past ten years it has been found that there is an inverse correlation between the two of about 60-70 percent. This means that as the dollar value raises, the prices of oil and commodities fall. The following chart shows the relationship between the strength of the US dollar and the price of the crude oil benchmark Brent.
xxiii Regulations With the energy sector being one of the most regulated in the economy, a change in governmental policies will impact how firms in the sector operate. The unexpected election of Trump has shaken up the energy sector, as investors react to the changes they now anticipate. Trump has previously voiced his disapproval of costly fuel regulations, and the possibility of a decrease in regulations had led to much speculation. As republicans now control the presidency, house and senate, many environmental restrictions on energy projects will now most likely move forward, mainly the Keystone Pipeline.
Industry Overview Tesoro operates in the oil, gas & consumable fuels industry. This industry is largely led by the integrated oil & gas sub-industry, accounting about for about 53.2% of its market capitalization according to S&P Global Market Intelligencexxiv. This is due to the fact that integrated companies engage in all three segments the industry has to offer. The industry’s three main segments are upstream, midstream, and downstream. Upstream: Involves the exploration and production of oil and natural gas which are then sold to the downstream segment.
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These firms can be the most profitable but tend to be riskier and capital-intensive. Boom-or-bust mentality. Midstream: Firms that process, store and transport oil, natural gas, and petroleum products. These energy materials are generally transported by large networks of pipelines or by ship. Downstream: Also known as the refining and marketing segment which focuses on converting the extracted resources from the upstream section into petroleum products and selling them to end consumers. Tesoro participates in the downstream operations as an independent US refining and marketing company. The company generates most of its revenue by refining crude oil and selling transportation fuels to wholesalers or retailers. Recent Developments and Trends Crude Oil Price Uncertainty Since falling significantly in 2015 and reaching a low of $28/barrel in February of 2016, oil prices have recovered about 60%. West Texas Intermediate (WTI) crude oil has taken up residency in the $44-$48 per barrel range as of November. Continued bearish reports regarding supply by the International Energy Agency and Energy Information Administration has put the energy market at risk for another volatile year in 2017. Oil prices have been volatile and we believe they will remain volatile slowly rebounding in the next five years. This is assumption is largely due to uncertainty about whether OPEC can implement the first output cuts in eight years and get producers outside the group to join in. We are skeptical OPEC will be able to finalize the Algiers accord when the group meets November 30th.
Refining Utilization Petroleum product demand is driven by a combination of economic activity and weather. Refinery utilization is a good indicator of petroleum demand because it reveals what percentage of capacity refiners are being utilized at. In Q3 of 2016 Tesoro operated at 98% utilization and expects to operate at 90-96% in Q4 of 2016.xxv This expected drop in utilization is due to seasonality swings in product demand. This seasonality is represented in the graph as the dips in demand are during the cold winter season.
xxvi
The EIA forecasts total US consumption of liquid fuels will increase from 19.64 million b/d in 2016 to 19.90 million b/day in 2017. xxviiWe believe these forecasts are reasonable as prices continue to remain low and US GDP growth is slowly expected to rise, demand will increase and utilization will continue to remain high. Margins Environment Refining margins are the most influential driver of the downstream earnings. Because refining margins are heavily dependent on the price of crude oil and finalized petroleum products, refiners tend to be more profitable when crude oil prices fall. In order to approximate these margins, a common ration known as the 3-2-1 “crack spread” is used to signal the directional changes in the trading environment on refiners’ profitability. This is the most commonly ratio for the benchmark but can vary on location.
According to the EIA, global crack spreads were low in the third quarter of 2016 suggesting that refineries could face continued pressure. As we forecast modest growth demand for gas and a slow recovery in oil prices we expect these margins to decrease moving forward. Although the crack spread is a common benchmark, refining margins differ between firms based on other operating expenses such as transportation costs, regulation costs and different products produced. The Petroleum Administration for Defense Districts (PADDs) allows data to be aggregated and analyzed by regional petroleum product supply and movements. xxviii
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(Picture includes transportation costs and other fees) Tesoro’s refineries mainly operate in the PADD IV (Rocky Mountain) and PADD V (West Coast) regions. As the chart displays the PADD IV region has historically been on the low end while PADD V has been on the higher end. Interestingly, average domestic refiner acquisition costs of crude oil for the PADD V region for June, July, and August were $46.45, $43.45, and $43.13.xxix These prices for the corresponding months were the lowest compared to other regions only behind the PADD IV region. We believe this recent trend is a result of lessened US supply from the shale formations of North Dakota. With oil prices as low as they have been it has been less profitable to extract oil in that area. These supply restraints have made shipping crude oil by rail to further located refineries more expensive. According to the EIA, US crude oil production is forecasted to average 8.8 million b/d in 2016 and 8.7 million b/d in 2017.xxx With this slight decrease in production along with a modest increase in consumption as previously mentioned, the North Dakota shale area could reach its threshold to pump oil with more profit. We believe this threshold sits around $50-$55 per barrel. Government Policies and Regulation In the past refiners have faced upward pressure on costs due to acts passed by the Environmental Protection Agency (EPA). A recent proposal by the EPA would require refineries to increase the amount of biofuels mixed in petroleum products to meet the Renewable Fuels Standard. The change would require 18.8 billion gallons of ethanol and other biofuels to be blended into the US gasoline supply in 2017, an increase of 700 million gallons from 2016.xxxi The refining industry has been pushing hard to convince the EPA to relax the rules and with the recent election of President Trump they may have gotten the push they needed. Trump’s general energy policy is to utilize the abundant sources of oil the US has to offer and not so much in renewable resources. Competition Tesoro faces intense competition in the refining and marketing sub-industry. Based on their size and operations we have identified HollyFrontier, Valero Energy, Phillips 66, and Western Refining as pure plays. We decided not to include fully integrated oil companies because they generate revenue mainly through their upstream operations. HollyFrontier: Operates throughout the mid-continent, southwestern and Rocky Mountain regions. Owns five refineries and has a partnership with a logistics company. Due to its similar integrated structure, HollyFrontier is a potential close competitor. Western Refining: Owns and operates three refineries, has transportation assets and owns about 258 retail convenience stores. Mainly operates in the southwest with its two main refineries located in Texas and New Mexico. For similar reasons as HollyFrontier we believe Western Refining is comparable peer.xxxii
Phillips 66: Operates in the midstream and downstream sector. Phillips operates significantly more in the midstream compared to other comparable firms. Additionally, the firm has refineries in Europe which affects its refining margins compared to firms that solely operate in the US. Valero: Operates 15 refineries located in the US, Canada, and UK. Additionally, the company owns about 7,500 retail convenience stores and has strong presence throughout.xxxiii
xxxiv Compared to its peers, Tesoro is average as far as size and refining capacity. The important number here is Tesoro’s refining margin compared to its peers. In 2015 we expect all these numbers to fall due to the change in the refining environment. As of Q3 in 2016, Tesoro’s refining margin for the three months ended was $10.94xxxv. HollyFrontier’s, Valero’s, and Western Refining margins for the Q3 were $9.83, $9.08, and $12.02, respectively. Porters 5 Forces Power of Suppliers Exploration and Production companies have significant power on refineries due to the fact that they control the supply side of the market. When companies decide to cut or increase their supply, prices can fluctuate greatly. Based on the market’s reaction, the acquisition costs of crude oil can be favorable or harmful to refineries’ margins.xxxvi Power of Buyers Retailers and wholesalers will purchase from refineries based off convenience, location, price, and offered products. Competitive Rivalry Competition in the industry is extremely intense as firms have refineries in the same region. The size of the refinery is crucial as larger refineries possess greater capacity allowing to better meet demand Furthermore, the competitive advantages in the industry are based on being able to refine products at the lowest cost. This can be difficult depending on the commodities market and other variables. Threat of New Entrants Potential entrances into the industry are low due to governmental regulations, economies of scale, distribution channels, and high capital costs included in building a new refinery. Additionally, fixed costs are high for downstream operations and a high level of expertise in the industry is required to be successful.
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Company Analysis
Threat of Substitutes The main threat of substitutes comes from alternative sources of energy such as solar, wind and hydroelectric. These sources of energy have become favored by some people as our negative effects on the environment have become pronounced. The growth rate of these sources is extremely unpredictable but could have an impact down the road.
General Information Tesoro’s performance is heavily susceptible to the change in crude oil prices. As they look to more fully integrate their business, we anticipate earnings will stabilize. With refineries spread out across the western U.S. and a diversified client base for their marketing segment, Tesoro is well positioned within the oil refining and marketing industry.
xxxvii Compared to the industry, Tesoro is heavily indebted. As of 9/30/16, the company has $4.6 billion worth of debt on its balance sheet.xxxviii The company has a current credit rating of BB+, one below an investment grade rating.xxxix Recent managerial guidance had indicated the company’s desire to reach investment grade rating. With the risk of potential rise in interest rates, we anticipate Tesoro reaching an investment grade rating and attempting to lower their interest rate obligations as they have bonds due in early 2022.xl Products and Markets Through the 3rd quarter of 2016, Tesoro’s 2016 revenues were broken down into 56.42% refining, 40.5% marketing, and 3.17% from the logistics operations.xli Refining Through its 7 refineries, Tesoro has a current throughput capacity of 895 mbpd and generally operates above 90% utilization year round. The segment purchases 59% of its crude oil from domestic sources and 41% from foreign countries.xlii In their refineries, Tesoro processes both heavy and light crude oil, which vary in price. Light crude oil is typically more expensive and is used to produce higher quality transportation fuels such as
gasoline and diesel fuel. Heavy crude oil, when refined, is used to make heavy oil fuels. Tesoro sells all of these products, and their refined product sales are broken down into 4 categories as follows.
xliii The profitability of buying crude oil and selling refined products is widely dependent on ‘crack spreads’, or the difference between market prices for oil and the sale price of refined products. Tesoro utilizes the West Coast and Mid Continent crack spreads in analyzing their performance. Each is calculated using different crude oil benchmarks (Alaska North Slope crude oil and West Texas Intermediate, or WTI, respectively). As a result, Tesoro’s refining operations are widely dependent on the prices of these two commodities. The refining operations of Tesoro are broken up into 3 regions; California, Pacific North West, and Midcontinent. Each region has a different supply and thus depends on the prices of oil in their respective region. The Martinez and Los Angeles refinery in the California region account for 65.13% of Tesoro’s total refined revenues.xliv Refineries tend to do very well when the price of oil falls, as crack spreads widen. Going forward, much of Tesoro’s refining operations are dependent on the prices of crude oil benchmarks, significantly the price of WTI. The majority of gasoline and diesel fuel sales are to the company’s marketing segment, but they also sell to independent retailers. The remaining refining revenue stems from bulk sales of all products to independent unbranded distributors in the wholesale market. Marketing The marketing segment of Tesoro has a diversified client base to sell their products to. While they have a strong relationship with Shell® and ExxonMobil® brands, they also sell large quantities to ARCO®, USA Gasoline™, Rebel™, and Tesoro® brands.xlv Of their 2,400 retail locations, over 1,400 are in California. Tesoro Logistics (TLLP) TLLP is a publicly traded subsidiary of Tesoro that operates with three segments: gathering, processing, and terminalling and transporting. They currently own over 3,500 miles of oil and gas pipelinesxlvi, and are actively seeking permits for more pipeline projects as they look to grow this portion of their business. The gathering segment of Tesoro operates through crude oil and natural gas gathering systems throughout the western and mid-continental United States. Once gathered, the inputs are ready
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for transportation to Tesoro’s refineries. For the fiscal year ended 2015, the Gathering segment of Tesoro Logistics transported 1,077 thousands of MMBtu/dayxlvii. The processing segment of operates as a processing complex for Tesoro and for other producers. The segment has a throughput capacity of 15,000 barrels per day for fractionation complexes and 1,432 MMcf/d for processing complexes.xlviii The terminalling and transporting segment of Tesoro consists of 25 different terminals and storage facilities. Based out of the western United States, the segment has an available terminally capacity of 1,850 crude oil and refined products mbpd.xlix Financial Analysis/Recent Earnings Segment Margins Through September 30th 2016, Tesoro’s refining segment posted an operating income of $475 million, down substantially from the $1,843 million in the same period the previous year.l While the sale of total refined products has gone up, the decrease in performance as attributable to deteriorating gross refining margins, or $/throughput barrel. They decreased $6.47 per barrel to 10.75. In the company’s quarterly earnings conference call, they gave three reasons causing the deteriorating margins. As oil prices have started to recover through 2016, crack spreads have narrowed. The result is an overall lower refining margin environment across the boards for all refineries. Of the 4 companies that have reported quarterly earnings in the group we have deemed Tesoro’s competition, they have outperformed 3 of them on the basis of profit per barrel. The other two reasons for lower refining margins were rising RIN prices and an effort to decrease inventory to raise cash.li As mentioned previously, a Trump presidency could lessen the strict regulation of RIN prices, helping out all oil refineries. This factor, along with the company’s apparent competitive advantage in operating efficiency measured by $/throughput barrel, make us confident in our assumptions of Tesoro’s refining segment performing well in the near future, despite recovering oil prices. Tesoro’s marketing segment has also fared worse through 2016 than 2015. The segment operating income fell form $724 million, to $661. This stems from the company’s decrease in fuel margin, or cents per gallon, which decreased from 14.8 to 13.2 for the 9-month period ended 9/30/16.lii EPS and Dividend Summary Tesoro has underperformed EPS estimates for three out of the last 4 quarters. For the 3rd quarter of 2016, they posted earnings of $1.32, eleven cents under the consensus average.
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For the 2016 Fiscal year, our model projects earnings per share of $5.25, down from $12.5 in the 2015 fiscal year. Moving forward, we do not expect Tesoro to underperform expectations. Other Valuation Metrics Historically, Tesoro is trading around their 5-year average for P/E and P/CF. We anticipate these numbers to grow, as the company’s sales climb as they look to expand.
liv Competition As mentioned previously, Tesoro considers their peers to be Valero, Marathon Petroleum, Marathon Petroleum, and HollyFrontier. For the 5-year period ended at the end of the last fiscal year, Tesoro’s stock returns have outperformed their peers by a wide margin, and the S&P 500 as well.
lv Another notable ratio to consider between peers is total debt/total capitalization. Because the industry is capital intensive, it is important to measure a company’s financial leverage. Tesoro sits on the high end at a 5- year average of 38.26%. Regarding Tesoro’s peers, Phillips 66, Valero, Western Refining, and HollyFrontier have leverage ratios of 21.03%, 27.08%,52.29%, and 16.77% respectively. lvi As Tesoro plans to grow we expect it to take accumulate an even higher percentage of debt Future Outlook Looking forward, management has laid out strategic priorities in their effort to achieve a ‘highly integrated business model”. Doing so will steer the company towards more stable earnings, as refineries are very sensitive to changes in the price of crude oil commodities. These strategic priorities are: operational efficiency and effectiveness, value chain optimization, financial
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Valuation Analysis
discipline, value-driven growth, and high performing culture.lvii The company has four projects they are actively working towards implementing to achieve their strategic priorities. Starting in 2017, the company will start the process of physically connecting their refineries in Wilmington and Carson California. They have been actively seeking approval and expect to begin the process in 2017. When completed, Tesoro estimates the project will have cost $450 million, but generate $100 million in profitability per year.lviii Another tentative project is to build a crude oil facility on the Columbia River in Vancouver. Doing so would allow direct transportation of crude oil throughout the entire west coast. The project is heavily dependent on federal approval, but Tesoro is optimistic. The final two projects planned for 2017 are geared towards improving upon their operational efficiency and value-driven growth. Management is actively seeking a permit that would allow them to begin production of a petrochemical feedstock to be sold in foreign markets, primarily Asia. Further diversification of their products will help with the integration of the company. The final project involves installing an isomerization unit that will drive down the cost of refining gasoline. Management expects it will require $1 billion in revenue but drive over $300 million in earnings.lix The future of Tesoro is heavily dependent on the company’s ability to increase their ROIC. As the company is looking to expand organically and inorganically, how efficiently they implement these changes will dictate their future profitability.
Revenue Decomposition Total refined revenues from refining operations were forecasted by multiplying the sales volume of refined products by our predicted average sales price, then multiplying by 365, as the production is in thousands of barrels per day. For 2016, we are projecting a decrease in total refined revenues of 17.30%, due to a decrease in the average sales price of the products. Moving forward, as oil prices continue to rise and the company expands its throughput capacity organically and through acquisitions, we project refined revenue to grow at a comfortable rate. The marketing segment of Tesoro sells gasoline and diesel fuel to over 2,467 retail locations mainly in the western Unites States, and we expect this number to grow. As mentioned earlier, Tesoro plans to increase the marketing and transporting segment of their business, having a smaller percentage of total revenues come from refining activities. The integration will allow the company to stabilize their earnings, avoiding the volatility refineries see with changes in oil prices. This guidance was key in our projections, as forecasted the marketing and logistics segments to grow at a faster rate than the refinery in the next 3 years.
Cost of Capital We calculated Tesoro’s weighted average cost of capital to be 7.65%. Key to our calculation was the use of the capital asset pricing model to find the cost of equity. For the company’s beta, we used a geometric average of daily returns over a 2-year period. While there is skepticism over the accuracy of using daily returns to calculate beta, we feel the result, a beta of 1.252lx, accurately reflects Tesoro’s volatility relative to the market. For the risk-free rate, we used 2.48%, the most recent yield on a 30-year U.S. treasury bond.lxi Given the current state volatility within the market, we used a higher than average market risk premium of 6%. These inputs gave us our calculated cost of equity of 9.99% To calculate Tesoro’s pretax cost of debt, we used an average of Valero, ConocoPhillips, Marathon Petroleum, and Phillips 66 bond yields with maturities close to 30 years. This gave us an average of 6%.lxii DCF/EP Analysis As part of our DCF and EP valuation, we forecasted the balance sheet and income statement 6 years out, with the last year as the continuing value year. Given the recent outlook of the oil industry, we feel 6 years is ample time for the industry to reach steady state growth. After conducting the valuation, we arrived at an adjusted stock price of $94.19. As Tesoro has been trading around the $82-$86 price range, we believe the stock is slightly undervalued. However, it is important to note that our projected ROIC is in close proximity to the WACC. As a result, our economic profits range from slightly negative in the coming years as the firm looks to expand organically and inorganically, and positive in the last two years. As our sensitivity analysis points out, small changes in the calculation of the WACC can cause these economic profits to change from negative to positive. This is especially important because as the firm looks to grow, they will either by adding or destroying shareholder value. This uncertainty plays into why we are recommending a hold in Tesoro, even though our model calculates the stock is slightly undervalued. Price to Earnings Valuation While we feel our DCF analysis most accurately portrays the value for Tesoro, we conducted a price to earnings analysis using 5 of Tesoro’s competitors. In the company’s most recent 10K they list Valero Energy Corporation, Marathon Petroleum Corp, HollyFrontier Corp, and Phillips 66 as their “peer group”. We also added Western Refining Inc. to the list, a smaller refinery that has similar growth, profitability, and risk metrics. Using earnings per share estimates from Thomsonone Investment Banking, we calculated an implied value of $121.23 using 2016 EPS data, and $81.06 using 2017 EPS data. The stock price of $121.23 was calculated by multiplying our estimated EPS value for 2016 by the average P/E ratios of our peers, which was 23.1. This stock price, along with Tesoro’s P/E ratio of 16.3 relative to the peer group, gives us confidence in saying that Tesoro is indeed undervalued.
Dividend Discount Model Our dividend discount analysis gave us an intrinsic value of $61.14. Tesoro’s past dividend policy made this model difficult
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Sensitivity Analysis
to predict. Following the financial crisis of 2008/2009, Tesoro suspended its payout of dividends after operating at a loss in fiscal 2009 and 2010. The firm recovered and paid a yearly dividend of $.27 in 2011 with a payout ratio of 4%. They have increased dividends each subsequent year, and 2016’s dividend payments are expected to total $2.10, up from $1.85 the previous year. Despite a projected net income less than half of the previous year, Tesoro was able to increase their dividends per share by increasing their payout ratio to 40%. They have also implemented a repurchase program that is reflected in our model. There is not much managerial guidance about their future payout policy, but we expect Tesoro to stay around a 40% payout policy as earnings stabilize.
CV ROIC vs WACC CV ROIC
94.13 4.71% 5.71% 6.71% 7.71% 8.71% 9.71% 10.71%
8.28% 61.53 70.50 76.80 81.46 85.05 87.91 90.23
8.08% 64.60 73.95 80.51 85.38 89.12 92.10 94.52
7.88% 67.88 77.64 84.49 89.56 93.47 96.58 99.10
WACC 7.68% 71.39 81.59 88.75 94.05 98.13 101.38 104.01
7.48% 75.16 85.83 93.32 98.86 103.14 106.53 109.29
7.28% 79.21 90.39 98.23 104.04 108.52 112.08 114.97
7.08% 83.58 95.31 103.54 109.64 114.33 118.06 121.10
6.88% 88.32 100.64 109.29 115.69 120.63 124.55 127.73 The CV of return on invested capital (ROIC) is an important factor because it acts as a value driver into perpetuity. A 1% increase alone drives the intrinsic value up to $98.13. This driver is heavily dependent on calculations of NOPLAT and invested capital within our model. Due to the volatility within the energy sector, our forecasted calculations could differ from actual results in the future. If NOPLAT continues to rise as we have forecasted and invested capital stays relatively similar, then CV ROIC will increase, creating higher value for the company. As the spread between CV ROIC and WACC varies it will subsequently create changes to our Economic Profit. CapEx Rate vs WACC
94.13 3.5% 4.5% 5.5% 6.5% 7.5% 8.5% 9.5%
8.28% 85.65 83.54 81.44 79.35 77.25 75.16 73.07
8.08% 89.67 87.51 85.36 83.21 81.06 78.92 76.77
7.88% 93.96 91.75 89.55 87.34 85.14 82.94 80.74
WACC 7.68% 98.56 96.30 94.03 91.77 89.51 87.25 84.99
7.48% 103.50 101.17 98.84 96.52 94.20 91.88 89.56
7.28% 108.81 106.42 104.03 101.63 99.25 96.86 94.47
6.88% 120.76 118.21 115.67 113.13 110.60 108.07 105.54 The rate at which companies invest to grow organically and inorganically is important to assess whether or not they are adding or destroying value. As mentioned previously, when the
spread between ROIC and WACC increases, value increases accordingly. The table indicates that if our assumed capex rate would’ve been 6.5%, Tesoro would be destroying value, resulting in a lower stock price of $88.01. Economic conditions and market opportunities could affect Tesoro’s capital expenditures rate. Pre-Tax Cost of Debt vs CV NOPLAT
CV NOPLAT
94.13 1.25% 1.50% 1.75% 2.00% 2.25% 2.50% 2.75%
6.75% 94.90 94.95 95.00 95.05 95.11 95.17 95.24
6.50% 94.63 94.67 94.71 94.75 94.80 94.85 94.90
6.25% 94.35 94.38 94.41 94.44 94.48 94.52 94.56
6% 94.06 94.08 94.10 94.13 94.15 94.18 94.21
5.75% 93.77 93.78 93.79 93.80 93.82 93.83 93.85
5.50% 93.47 93.47 93.47 93.48 93.48 93.48 93.48
5.25% 93.17 93.16 93.15 93.14 93.13 93.12 93.11
pretax cost of debt
Although the impact of these two factors isn’t as noticeable compared to other sensitivity tables, they have a significant impact in our DCF analysis. CV NOPLAT assumes consistent growth into perpetuity, which drives our discount factor. Likewise, the pretax cost actively changes our WACC calculation, which effects our discount factor. Based on our assumptions regarding the refining margin environment, Tesoro’s growth could vary based on numerous variables. Beta Vs. Market Risk Premium
Beta
94.13 1.102 1.152 1.202 1.252 1.302 1.352 1.402
6.75% 95.15 90.59 86.35 82.39 78.69 75.21 71.95
6.50% 99.12 94.46 90.11 86.06 82.26 78.69 75.34
6.25% 103.35 98.57 94.12 89.96 86.06 82.40 78.97
MRP 6.00% 107.86 102.96 98.39 94.13 90.13 86.37 82.84
5.75% 112.68 107.66 102.97 98.59 94.48 90.62 86.99
5.50% 117.85 112.69 107.88 103.37 99.15 95.18 91.44
5.25% 123.40 118.10 113.16 108.52 104.18 100.09 96.25
Given the industry that Tesoro operates in is highly cyclical, we found it crucial to assess potential changes in the beta and market risk premium. Highly cyclical firms can have a larger beta range than most depending on economic stability. The effects are evident in our analysis given, everything else held constant, a 5 basis point increase in our beta would drop the stock price to $86.66. The effect that MRP has on our stock price is even more pronounced as a .50% decrease would increase the stock to $104.01. Minor changes to these variables have a significant impact because of the effects on our WACC calculation and overall discount rate of our DCF model.
11
Important Disclaimer This report was created by students enrolled in the Security Analysis (6F:112) class at the University of Iowa. The report was originally created to offer an internal investment recommendation for the University of Iowa Krause Fund and its advisory board. The report also provides potential employers and other interested parties an example of the students’ skills, knowledge and abilities. Members of the Krause Fund are not registered investment advisors, brokers or officially licensed financial professionals. The investment advice contained in this report does not represent an offer or solicitation to buy or sell any of the securities mentioned. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Krause Fund may hold a financial interest in the companies mentioned in this report. i Tesoro.com ii All company profile statistics from Factset iii “Bloomberg Markets Outlook”. Retrieved from Bloomberg.com iv Bloomberg.com v EIA.gov vi “What Drives Crude Oil Prices.” U.S. Energy Information Administration. https://www.eia.gov/finance/markets/demand-nonoecd.cfm vii “International Energy Outlook.” U.S. Energy Information Administration. http://www.eia.gov/forecasts/ieo/world.cfm viii International Energy Outlook.” U.S. Energy Information Administration. http://www.eia.gov/forecasts/ieo/world.cfm ix “China GDP Annual Growth Rate.” Trading Economics. http://www.tradingeconomics.com/china/gdp-growth-annual/forecast x “India GDP Growth Forecast 2015-2020.” Knoema. https://knoema.com/xxnxggb/india-gdp-growth-forecast-2015-2020-and-up-to-2060-data-and-charts xi “Sector-wise contribution of GDP of India.” Statistics Times. http://statisticstimes.com/economy/sectorwise-gdp-contribution-of-india.php xii “Real GDP Forecast.” OECD Data. https://data.oecd.org/gdp/real-gdp-forecast.htm xiii “Short-Term Energy Outlook.” U.S. Energy Information Administration. http://www.eia.gov/forecasts/STEO/ xiv Oil Market Report xv http://www.energyeconomist.com/a6257783p/opec/quota.html xvi Oil Market Report xvii Oil Market Report
xviii “International Rig Count.” Baker Hughes. http://phx.corporate-ir.net/phoenix.zhtml?c=79687&p=irol-rigcountsintl xix HISMarket.com xx “Offshore Rig Day Rates.” Rigzone. http://www.ww.oilskills.com/data/dayrates/ xxi “EIA Petroleum Status Report.” Bloomberg Calendar. https://www.bloomberg.com/markets/economic-calendar xxii Fred.stlouisfed.org xxiii market realist xxiv S&P Global Market Intelligence xxv Tesoro Q3 2016 Earnings Call. Retrieved from Bloomberg xxvi “Consulting Engineers”: Turnermason.com xxvii EIA.gov forecast report xxviii EIA.gov xxix EIA.gov petroleum and other liquids data xxx EIA. Gov US liquid forecasts xxxi “Mergent First Research: Industry Report” (http://mergent.firstresearch-learn.com/industry_detail.aspx?pid=155&chapter=4) xxxii Western Refining 2015 10K Report xxxiii Valero 2015 10K Report xxxiv Factset.com xxxv Tesoro 2016 Q3 10Q xxxvii Tesoro.com xxxviii Tesoro 2016 Q3 10Q xxxix Tesoro 2016 Q3 10Q xl Tesoro 2015 10K Report xli Tesoro 2016 Q3 10Q xlii Tesoro 2015 10K Report xliii Tesoro 2015 10K Report xliv Tesoro 2016 Q3 10Q xlv Tesoro 2015 10K Report xlvi Tesoro 2015 10K Report xlvii Tesoro 2015 10K Report xlviii Tesoro 2015 10K Report xlix Tesoro 2015 10K Report l Tesoro 2016 Q3 10Q Pg. 40 li Tesoro Q3 2016 Earnings Call. Retrieved from Bloomberg lii Tesoro 2016 Q3 10Q liii Yahoo Finance liv Factset: Tesoro lv Tesoro 2015 10K Report lvi Factset lvii Tesoro 2015 10K Report lviii Tesoro Q3 2016 Earnings Call. Retrieved from Bloomberg lix Tesoro lx Bloomberg.com lxi Bloomberg.com lxii Bloomberg.com
TESORORevenue DecompositionIn millions
Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV 2021E
Refining RevenuesRefined products 34846 37970 25997 21,168.98 24,506.14 27,239.30 30,603.28 33,493.28 36,945.40
Crude oil resales and other 1969 1456 946 1,114.16 1,289.80 1,433.65 1,610.70 1,762.80 1,944.49
Total Refined Revenues 36,815 39,426 26,943 22,283.1 25,795.93 28,672.95 32,213.98 35,256.09 38,889.89
Growth Rate 13.81% 7.09% ‐31.66% ‐17.30% 15.76% 11.15% 12.35% 9.44% 10.31%
Refined Product Sales (Mbpd)Gasoline and gasoline blendstocks 429 507 510 625 718 754 769 785 797
Diesel fuel 176 206 204 240 264 270 276 279 285
Jet fuel 117 149 152 167 176 178 184 186 190
Heavy fuel oils, residual products and other 86 87 92 99 104 106 109 110 112
Total Refined Product Sales 808 949 958 1131 1262 1309 1337 1360 1384
Refined Product Sales (Mbpd) GrowthGasoline and gasoline blendstocks 20.17% 18.18% 0.59% 22.50% 15.0% 5.0% 2.00% 2.0% 2%
Diesel fuel 81.44% 17.05% ‐0.97% 17.50% 10.0% 2.5% 2% 1.3% 2%
Jet fuel ‐24.03% 27.35% 2.01% 10.00% 5.0% 1.5% 3% 2% 2%
Heavy fuel oils, residual products and other 1.18% 1.16% 5.75% 7.50% 5.5% 2.0% 2% 2% 2%
Total Refined Product Sales 16.59% 17.45% 0.95% 18% 12% 4% 2% 2% 2%
Product Sales Price and Cost ($/barrel)Average sales price 118.4 112.17 77.7 54 56.0 60.0 66.0 71.0 77.0
Average costs of sales 109.64 102.59 65.07 43 45.0 50.0 56.0 62.0 69.0
Refined Product Sales Margin 8.76 9.58 12.63 11.0 11.0 10.0 10.0 9.0 8.0
Marketing:
Fuel 20557 23701 18081 15,368.85 21,516.39 22,592.21 23,495.90 24,200.77 24,684.79
Other non-fuel 239 240 63 56.7 62.37 64.24 66.17 67.49 68.17
Total Marketing Revenues 20,796.00 23,941.00 18,144.00 15,425.55 21,578.76 22,656.45 23,562.07 24,268.27 24,752.96
Marketing Revenue GrowthFuel 237.78% 15.29% ‐23.71% ‐15.00% 40% 5% 4% 3% 2%
Other non-fuel ‐1.24% 0.42% ‐73.75% ‐10.00% 10% 3% 3% 2% 1%
Total Marketing Revenues Growth 228.63% 15.12% ‐24.21% ‐14.98% 39.89% 4.99% 4.00% 3.00% 2.00%
TLLP:
Gathering 90 135 339 372.90 466.13 559.35 643.25 720.44 734.85
Processing — 23 278 347.50 469.13 539.49 593.44 623.12 635.58
Terminalling and transportation 223 442 495 544.50 626.18 688.79 757.67 795.56 811.47
Total TLLP: 313.00 600.00 1,112.00 $1,264.90 $1,561.43 $1,787.64 $1,994.37 $2,139.11 $2,181.90
TLLP GrowthGathering — 50.00% 151.11% 10% 25% 20% 15% 12% 2%
Processing — — 1108.70% 25% 35% 15% 10% 5% 2%
Terminalling and transportation — 98.21% 11.99% 10% 15% 10% 10% 5% 2%
Total TLLP Growth — 91.69% 85.33% 14% 23% 14% 12% 7% 2%
Combined Sales 57,924.00 63,967.00 46,199.00 38,973.59 48,936.12 53,117.04 57,770.41 61,663.47 65,824.75
Intersegment sales (20,323.00) (23,334.00) (17,488.00) (14,214.64)$ (17,848.22)$ (19,373.10)$ (21,070.30)$ (22,490.20)$ (24,007.92)$
Total Revenues 37,601.00 40,633.00 28,711.00 $24,758.95 $31,087.90 $33,743.93 $36,700.11 $39,173.27 $41,816.83
Total Revenue Growth 14.03% 8.06% ‐29.34% ‐14% 26% 9% 9% 7% 7%
TESOROIncome Statement(In millions except per share amounts)
Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV 2021E
Revenues 37,612 40,607 28,644 24,759 31,088 33,744 36,700 39,173 41,817 Refining Segment 36815 39426 26943 22,283 25,796 28,673 32,214 35,256 38,890
Marketing 20,796.00 23,941.00 18,144.00 15,426 21,579 22,656 23,562 24,268 24,753
Other (TLLP and Intersegment Sales) (20,010.00) (22,734.00) (16,376.00) (12,950) (16,287) (17,585) (19,076) (20,351) (21,826)
Costs and Expenses:COGS 35,884 38,549 24,956 22,538 28,541 31,092 33,908 36,204 38,763
Depreciation & Amortization Expense 489 562 756 730 806 823 841 882 900
Depreciation 322 363 491 536 541 565 588 607 624
Amortization of Intangibles 13 17 43 43 43 43 43 43 43
Amortization of Deferred Charges 154 182 222 151 222 215 210 232 233
SG&A Expense 275 323 340 224 281 320 362 366 394
Operating Income 964 1,173 2,592 1,267 1,460 1,509 1,590 1,722 1,760Net Nonoperating Income 3 24 (27) (5) (3) (11) (6) (7) (8)
Interest Expense 170 260 253 244 281 302 325 335 345
Net Unusual Expense 136 (502) (282) (64) (83) (159) (218) (161) (137)
Pretax Income 680 1,464 2,630 1,082 1,259 1,355 1,477 1,542 1,544Income Taxes 246 547 936 394 458 493 537 561 562
Minority Interest 42 45 150 47 55 61 67 71 75
Net Earnings from Discontinued Operations 20 (29) (4) (4) (12) (7) (8) (9) (8)
Net Income 412 843 1,540 637 734 794 865 901 899
EPS (recurring) 3.10 6.56 12.50 5.25 6.04 6.57 7.19 7.56 7.61
Total Shares Outstanding 131.80 128.50 123.20 121 121 121 120 119 118
Dividends per Share 0.90 1.10 1.85 2.10 2.42 2.63 2.88 3.02 3.04
Payout Ratio 29.0% 16.8% 14.8% 40.0% 40.0% 40.0% 40.0% 40.0% 40.0%
TESOROCommon Size Income Statement*Interest Expense not at a % of revenues
Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV 2021E
Revenues 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Costs and Expenses:COGS 95.41% 94.93% 87.12% 91.03% 91.81% 92.14% 92.39% 92.42% 92.70%
Depreciation & Amortization Expense 1.30% 1.38% 2.64% 2.95% 2.59% 2.44% 2.29% 2.25% 2.15%
Depreciation 0.86% 0.89% 1.71% 2.16% 1.74% 1.67% 1.60% 1.55% 1.49%
Amortization of Intangibles 0.03% 0.04% 0.15% 0.17% 0.14% 0.13% 0.12% 0.11% 0.10%
Amortization of Deferred Charges 0.41% 0.45% 0.78% 0.61% 0.71% 0.64% 0.57% 0.59% 0.56%
SG&A Expense 0.73% 0.80% 1.19% 0.90% 0.90% 0.95% 0.99% 0.94% 0.94%
Operating Income 2.56% 2.89% 9.05% 5.12% 4.70% 4.47% 4.33% 4.40% 4.21%
Net Nonoperating Income 0.01% 0.06% -0.09% -0.02% -0.01% -0.03% -0.02% -0.02% -0.02%
Interest Expense 0.45% 0.64% 0.88% 0.99% 0.90% 0.90% 0.88% 0.85% 0.82%
Net Unusual Expense 0.36% -1.24% -0.98% -0.26% -0.27% -0.47% -0.59% -0.41% -0.33%
Pretax Income 1.81% 3.61% 9.18% 4.37% 4.05% 4.01% 4.02% 3.94% 3.69%
Income Taxes 0.65% 1.35% 3.27% 1.59% 1.47% 1.46% 1.46% 1.43% 1.34%
Minority Interest 0.11% 0.11% 0.52% 0.19% 0.18% 0.18% 0.18% 0.18% 0.18%
Net Earnings from Discontinued Operations 0.05% -0.07% -0.01% -0.02% -0.04% -0.02% -0.02% -0.02% -0.02%
Net Income 1.10% 2.08% 5.38% 2.57% 2.36% 2.35% 2.36% 2.30% 2.15%
TESOROBalance Sheet(In millions except per share amounts)
Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV 2021E
Assets
Cash & Short-Term Investments 1,238.00 1,000.00 942.00 1,946 2,377 2,845 3,173 3,706 4,132
Net Receivables 1,313.00 1,435.00 792.00 808 991 1,037 1,165 1,232 1,309
Inventories 2,565.00 2,439.00 2,302.00 1,722 2,176 2,473 2,604 2,797 3,006
Other Current Assets 210.00 200.00 271.00 165 218 260 262 285 308
Total Current Assets 5,326.00 5,074.00 4,307.00 4641 5762 6615 7203 8021 8755
Property, Plant & Equipment
Property, Plant & Equipment - Gross 9,123.00 11,633.00 12,562.00 13,504 14,382 15,317 16,312 17,210 18,156
Accumulated Depreciation 2,248.00 2,588.00 3,021.00 3,557 4,098 4,663 5,251 5,858 6,482
Net Property, Plant & Equipment 6,875.00 9,045.00 9,541.00 9,947 10,284 10,654 11,061 11,352 11,674
Total Investments and Advances 114.00 170.00 159.00 148 159 155 154 156 155
Intangible Assets
Net Goodwill 41.00 196.00 188.00 188 188 188 188 188 188
Intangible Assets,gross 1,388.00 1,417.00 1,417 1,417 1,417 1,417 1,417 1,417
Accumulated Amortization 166.00 206.00 249 292 335 378 421 464
Net Other Intangibles 263.00 1,222.00 1,211.00 1,168 1,125 1,082 1,039 996 953
Net Intangible Assets 304.00 1,418.00 1,399.00 1,356 1,313 1,270 1,227 1,184 1,141
Other Assets 770.00 877.00 926.00 1,052 1,062 1,128 1,236 1,288 1,355
Total Assets 13,389.00 16,584.00 16,332.00 17,144 18,579 19,822 20,882 22,000 23,080
Liabilities & Shareholders' Equity
ST Debt & Curr. Portion LT Debt 6.00 6.00 6.00 7 7 8 8 8 9
Accounts Payable 2,596.00 2,470.00 1,568.00 1,558 1,924 2,028 2,199 2,398 2,541
Income Tax Payable 11.00 54.00 0.00 19 22 16 24 24 22
Other Current Liabilities 795.00 936.00 956.00 640 853 975 1,005 1,093 1,173
Total Current Liabilities 3,408.00 3,466.00 2,530.00 2,224 2,806 3,027 3,236 3,523 3,746
Long-Term Debt 2,823.00 4,254.00 4,067.00 4,677 5,028 5,405 5,567 5,734 5,906
Provision for Risks & Charges 551.00 684.00 617.00 696 693 738 830 858 898
Deferred Tax Liabilities 1,018.00 1,098.00 1,222.00 1,277 1,341 1,409 1,484 1,562 1,641
Other Noncurrent Liabilities 104.00 106.00 156.00 89 87 133 127 133 151
Total Liabilities 7,904.00 9,608.00 8,592.00 8,964 9,955 10,713 11,244 11,810 12,341
EquityCommon Equity 1,212.00 1,281.00 1,417.00 1,428 1,439 1,449 1,460 1,471 1,482
Retained Earnings 3,940.00 4,642.00 5,954.00 6,336 6,777 7,253 7,772 8,313 8,853
Accumulated other comprehensive loss (52.00) (149.00) (149.00) (149) (149) (149) (149) (149) (149)
Treasury Stock (798.00) (1,320.00) (2,009.00) (2,200) (2,310) (2,426) (2,547) (2,674) (2,808)
Total Shareholders' Equity 4,302.00 4,454.00 5,213.00 5,415 5,756 6,128 6,537 6,961 7,377
Accumulated Minority Interest 1,183.00 2,522.00 2,527.00 2,765 2,868 2,981 3,101 3,229 3,362
Total Equity 5,485.00 6,976.00 7,740.00 8,181 8,624 9,109 9,637 10,190 10,739
Total Liabilities & Shareholders' Equity 13,389.00 16,584.00 16,332.00 17,144 18,579 19,822 20,882 22,000 23,080
TESOROCommon Size Balance Sheet
Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E
Assets
Cash & Short-Term Investments 3.29% 2.46% 3.29% 7.86% 7.65% 8.43% 8.65% 9.46% 9.88%
Net Receivables 3.49% 3.53% 2.76% 3.26% 3.19% 3.07% 3.17% 3.14% 3.13%
Inventories 6.82% 6.01% 8.04% 6.95% 7.00% 7.33% 7.09% 7.14% 7.19%
Other Current Assets 0.56% 0.49% 0.95% 0.67% 0.70% 0.77% 0.71% 0.73% 0.74%
Total Current Assets 14.16% 12.50% 15.04% 18.74% 18.53% 19.60% 19.63% 20.48% 20.94%
Property, Plant & Equipment 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Property, Plant & Equipment - Gross 24.26% 28.65% 43.86% 54.54% 46.26% 45.39% 44.45% 43.93% 43.42%
Accumulated Depreciation 5.98% 6.37% 10.55% 14.37% 13.18% 13.82% 14.31% 14.95% 15.50%
Net Property, Plant & Equipment 18.28% 22.27% 33.31% 40.18% 33.08% 31.57% 30.14% 28.98% 27.92%
Total Investments and Advances 0.30% 0.42% 0.56% 0.60% 0.51% 0.46% 0.42% 0.40% 0.37%
Long-Term Note Receivable 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Intangible Assets 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Net Goodwill 0.11% 0.48% 0.66% 0.76% 0.60% 0.56% 0.51% 0.48% 0.45%
Net Other Intangibles 0.70% 3.01% 4.23% 4.72% 3.62% 3.21% 2.83% 2.54% 2.28%
Net Intangible Assets 0.81% 3.49% 4.88% 5.48% 4.22% 3.76% 3.34% 3.02% 2.73%
Other Assets 2.05% 2.16% 3.23% 4.25% 3.41% 3.34% 3.37% 3.29% 3.24%
Total Assets 35.60% 40.84% 57.02% 69.24% 59.76% 58.74% 56.90% 56.16% 55.19%
Liabilities & Shareholders' Equity 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
ST Debt & Curr. Portion LT Debt 0.02% 0.01% 0.02% 0.03% 0.02% 0.02% 0.02% 0.02% 0.02%
Accounts Payable 6.90% 6.08% 5.47% 6.29% 6.19% 6.01% 5.99% 6.12% 6.08%
Income Tax Payable 0.03% 0.13% 0.00% 0.08% 0.07% 0.05% 0.06% 0.06% 0.05%
Other Current Liabilities 2.11% 2.31% 3.34% 2.59% 2.74% 2.89% 2.74% 2.79% 2.81%
Total Current Liabilities 9.06% 8.54% 8.83% 8.98% 9.03% 8.97% 8.82% 8.99% 8.96%
Long-Term Debt 7.51% 10.48% 14.20% 18.89% 16.17% 16.02% 15.17% 14.64% 14.12%
Provision for Risks & Charges 1.46% 1.68% 2.15% 2.81% 2.23% 2.19% 2.26% 2.19% 2.15%
Deferred Tax Liabilities 2.71% 2.70% 4.27% 5.16% 4.31% 4.18% 4.04% 3.99% 3.92%
Other Liabilities 0.28% 0.26% 0.54% 0.36% 0.28% 0.40% 0.35% 0.34% 0.36%
Total Liabilities 21.01% 23.66% 30.00% 36.20% 32.02% 31.75% 30.64% 30.15% 29.51%
EquityAdditional Paid-In Capital/Capital Surplu 3.22% 3.15% 4.95% 5.77% 4.63% 4.29% 3.98% 3.75% 3.54%
Retained Earnings 10.48% 11.43% 20.79% 25.59% 21.80% 21.49% 21.18% 21.22% 21.17%
Accumulated other comprehensive loss -0.14% -0.37% -0.52% -0.60% -0.48% -0.44% -0.41% -0.38% -0.36%
Treasury Stock -2.12% -3.25% -7.01% -8.89% -7.43% -7.19% -6.94% -6.83% -6.71%
Total Shareholders' Equity 11.44% 10.97% 18.20% 21.87% 18.52% 18.16% 17.81% 17.77% 17.64%
Accumulated Minority Interest 3.15% 6.21% 8.82% 11.17% 9.23% 8.84% 8.45% 8.24% 8.04%
Total Equity 14.58% 17.18% 27.02% 33.04% 27.74% 27.00% 26.26% 26.01% 25.68%
Total Liabilities & Shareholders' Equity 35.60% 40.84% 57.02% 69.24% 59.76% 58.74% 56.90% 56.16% 55.19%
TESOROCash Flow Statement(In millions)
Fiscal Years Ending Dec. 31 2013 2014 2015
Operating Activities
Net Income 454.00 888.00 1,690.00
Depreciation and Depletion 322.00 363.00 491.00
Amortization of Intangible Assets 168.00 199.00 265.00
Other Funds (451.00) (146.00) 101.00
Funds from Operations 659.00 1,550.00 2,612.00
Changes in Working Capital 200.00 (186.00) (481.00)
Net Operating Cash Flow 859.00 1,364.00 2,131.00
Investing Activities
Capital Expenditures (570.00) (685.00) (1,030.00)
Net Assets from Acquisitions (2,237.00) (2,496.00) (97.00)
Sale of Fixed Assets & Businesses 539.00 0.00 0.00
Other Funds (309.00) 9.00 (2.00)
Net Investing Cash Flow (2,577.00) (3,172.00) (1,129.00)
Financing Activities
Cash Dividends Paid (121.00) (141.00) (228.00)
Change in Capital Stock 328.00 468.00 (532.00)
Issuance/Reduction of Debt, Net 1,187.00 1,402.00 (111.00)
Other Funds (77.00) (159.00) (189.00)
Net Financing Cash Flow 1,317.00 1,570.00 (1,060.00)
Net Change in Cash (401.00) (238.00) (58.00)
Beg. Cash 1,639.00 1,238.00 1,000.00
End Cash 1,238.00 1,000.00 943.00
TESOROCash Flow Statement(In millions)
Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E CV 2021E
Operating Activities
Net Income 637 734 794 865 901 899 Depreciation and Depletion 536 541 565 588 607 624
Amortization of Intangible Assets 43 43 43 43 43 43
Changes in Working Capital
less receivables 16 183 46 128 67 77
less inventoreis (580) 454 298 130 194 209
less prepayments (106) 53 42 1 24 23
change deferred taxes 55 64 69 75 78 78
increase accounts payable (10) 366 104 171 199 144
increase other current liab (316) 213 122 30 88 80
Increase in Income Tax Payable 19 4 (6) 7 (0) (1)
increase in other non-current liab. (67) (2) 46 (7) 7 17
Net Operating Cash Flow 1,568 1,271 1,352 1,513 1,638 1,577
Investing Activities
Capital Expenditures (942) (878) (935) (996) (897) (947)
Total Investments and Advances 11 (11) 4 1 (2) 1
intangible assets ‐ ‐ ‐ ‐ ‐ ‐
other assets (126) (9) (67) (108) (52) (67)
Net Investing Cash Flow (1,057) (898) (998) (1,102) (951) (1,013)
Financing Activities
Cash Dividends Paid (255) (294) (318) (346) (360) (360)
Proceeds from Issuance of LT Debt 610 351 377 162 167 172
Accumulated Minority Interest 238 103 113 119 128 132
Provision for Risks and Charges 79 (4) 46 92 28 39
Short term debt and Current Portion of LT Debt 1 1 1 0 0 0
Repurchases of Common Stock (191) (110) (116) (121) (127) (134)
Proceeds from Issuance of Common Stock 11 11 11 11 11 11
Net Financing Cash Flow 493 58 114 (83) (153) (139)
Net Change in Cash 1,004 431 468 328 533 425
TESOROValue Driver Estimation
Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV 2021E
Marginal Tax Rate 36.18% 37.36% 35.59% 36.38% 36.38% 36.38% 36.38% 36.38% 36.38%
EBITA
Revenues 37,612.00 40,607.00 28,644.00 24,759 31,088 33,744 36,700 39,173 41,817
COGS excluding D&A 35,884.00 38,549.00 24,956.00 22,538 28,541 31,092 33,908 36,204 38,763
Depreciation 322.00 363.00 491.00 536 541 565 588 607 624
Amortization of Non‐Goodwill Intangibles 167.00 199.00 265.00 194 265 258 253 275 276
SG&A Expense 275.00 323.00 340.00 224 281 320 362 366 394
Implied Int on Operating Lease 57.66 74.53 82.78 91 94 97 101 104 107
EBITA 1,021.66 1,247.53 2,674.78 1,358 1,554 1,606 1,691 1,826 1,866
Adjusted Taxes
Provision for Income Taxes 246.00 547.00 936.00 394 458 493 537 561 562
Tax Shield on Interest Expense 61.50 97.14 90.04 ## ######### 102 110 118 122 125
Tax On Non Operating Income 1.09 8.97 (9.61) (2) (1) (4) (2) (2) (3)
Tax Shield on Unusual Expense 49.20 (187.56) (100.36) (23) (30) (58) (79) (59) (50)
Tax Shield on Implied lease Int 20.86 27.85 29.46 33 34 35 37 38 39
Total Adjusted Taxes 376.48 475.46 964.75 494 565 584 615 664 679
Deferred Taxes
Deferred Tax Assets 0.00 0.00 0.00 0 0 0 0 0 0
Deferred Tax Liability 850.00 1,018.00 1,098.00 1277 1341 1409 1484 1562 1641
Change in Deferred Taxes 35.00 168.00 80.00 179 64 69 75 78 78
NOPLAT 680.19 940.07 1,790.03 1,043 1,052 1,091 1,151 1,240 1,266
Invested Capita
Opertaing Current Assets
Normal Cash 376.12 406.07 286.44 248 311 337 367 392 418
Accounts Receivable 1,313.00 1,435.00 792.00 808 991 1037 1165 1232 1309
Inventory 2,565.00 2,439.00 2,302.00 1722 2176 2473 2604 2797 3006
Other Current Assets 210.00 200.00 271.00 165 218 260 262 285 308
Total 4,464.12 4,480.07 3,651.44 2,942 3,696 4,108 4,397 4,706 5,041
Current Operating Liabilitie
Accounts Payable 2,596.00 2,470.00 1,568.00 1,558 1,924 2,028 2,199 2,398 2,541
Income Tax Payable 11.00 54.00 0.00 19 22 16 24 24 22
Other Current Liabilitie 795.00 936.00 956.00 640 853 975 1,005 1,093 1,173
Total 3,402.00 3,460.00 2,524.00 2,217 2,799 3,019 3,228 3,514 3,737
Operating Working Capital 1,062.12 1,020.07 1,127.44 725 897 1,089 1,170 1,192 1,304
Net PP&E 6,875.00 9,045.00 9,541.00 9,947 10,284 10,654 11,061 11,352 11,674
Other LT Operating Assets
PV of Operating Leases 1,242.16 1,379.74 1,454.25 1,516 1,567 1,624 1,686 1,730 1,779
Net Intangible (Non‐Goodwil 263.00 1,222.00 1,211.00 1,168 1,125 1,082 1,039 996 953
Other 770.00 877.00 926.00 1,052 1,062 1,128 1,236 1,288 1,355
Other LT Operating Assets 2,275.16 3,478.74 3,591.25 3,736 3,754 3,834 3,961 4,014 4,087
Other LT Operating Liabilitie
Other Noncurrent Liabilitie 104.00 106.00 156.00 89 87 133 127 133 151
Total 104.00 106.00 156.00 89 87 133 127 133 151
Invested Capita
Operating Working Capita 1,062.12 1,020.07 1,127.44 725 897 1,089 1,170 1,192 1,304
Net PPE 6,875.00 9,045.00 9,541.00 9,947 10,284 10,654 11,061 11,352 11,674
Other LT Operating Assets 2,275.16 3,478.74 3,591.25 3,736 3,754 3,834 3,961 4,014 4,087
Other LT Operating Liabilitie 104.00 106.00 156.00 89 87 133 127 133 151
Invested Capita 10,108.28 13,437.81 14,103.69 14,319 14,848 15,443 16,065 16,425 16,915
ROICNOPLAT 680.19 940.07 1,790.03 1,043 1,052 1,091 1,151 1,240 1,266
Beg. Invested Capital 7,349.68 10,108.28 13,437.81 14,104 14,319 14,848 15,443 16,065 16,425
9.25% 9.30% 13.32% 7.40% 7.35% 7.35% 7.45% 7.72% 7.71%
FCFNOPLAT 680.19 940.07 1,790.03 1,043.07 1,052.36 1,090.76 1,150.82 1,239.61 1,265.74
Change In Invested Capital 2,758.60 3,329.53 665.88 215.76 528.16 595.46 622.10 359.51 490.36
(2,078.41) (2,389.46) 1,124.16 827.31 524.20 495.29 528.72 880.10 775.38
EPBeg. Invested Capital 7,349.68 10,108.28 13,437.81 14,104 14,319 14,848 15,443 16,065 16,425
ROIC 9.25% 9.30% 13.32% 7.40% 7.35% 7.35% 7.45% 7.72% 7.71%
WACC 7.68% 7.68% 7.68% 7.68% 7.68% 7.68% 7.68% 7.68% 7.68%
116.03 164.17 758.56 (40) (47) (49) (35) 6 5
TESOROWeighted Average Cost of Capital (WACC) Estimationin millions
Risk Free Rate 2.48%
Expected Market Return 8.48%
Beta 1.252
Market Risk Premium 6.00%
Cost of Equity 9.99%
years daily
1 1.546
2 1.252
Pre Tax Cost of Debt 6.00%
Marginal Tax Rate 36.38%
After tax cost of debt 3.82%
Weight of EquityShares Outstanding 119.30
Price $85.48 WeightsMarket Value 10,197.76$ 62.49%
Weight of DebtMarket value 4,667.00
PV of operating leases 1,454.25
Total Debt 6,121.25$ 37.51%
Enterprise Value 16,319.01$
Weighted Average Cost of Capital 7.68%
Cost of Equity
Cost of Debt
Capital Structure
Beta
TESORODiscounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models
Key Inputs:
CV Growth 2.00%
CV ROIC 7.71%
WACC 7.68%
Cost of Equity 9.99%
Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E 2021E
DCF ModelNOPLAT 1043 1052 1091 1151 1240 1266
Less: Change in IC 216 528 595 622 360 490
FCF 827 524 495 529 880 775
Continuing Value 16,513
Periods to Discount 1 2 3 4 5 5
Present Value 768 452 397 393 608 11,408
Value of Operations 14027Add:excess cash & st investments 656
Add:equity investments 159
Add:discontinued operations (4)
Add:minority interest 2527
less:pv of operating leases 1454
less:pension obligations 629
less: total debt 4667
less: PV ESOP 47
Total Value of Equity 10567
Shares Outstanding 119
Intrinsic Value: Unadjusted 88.57
Adjusted Stock Price 94.13
EP ModelNOPLAT 1043 1052 1091 1151 1240 1266
Beg IC 14104 14319 14848 15443 16065 16425
ROIC 7.40% 7.35% 7.35% 7.45% 7.72% 7.71%
WACC 7.68% 7.68% 7.68% 7.68% 7.68% 7.68%
EP (40) (47) (49) (35) 6 5
Continuing Value 88.02
Periods to discount 1 2 3 4 5 5
PV Of Ep (37) (40) (39) (26) 4 61
PV of economic profit (77)plus: Beginning IC 14,104
Value of Operations 14,027
Add:excess cash & st investments 656
Add:equity investments 159
Add:discontinued operations (4)
Add:minority interest 2527
less:PV of operating leases 1454
less:pension obligations 629
less: total debt 4667
less: PV ESOP 47
Total Value of Equity 10567
Shares Outstanding 119.30
Intrinsic Value (Unadjusted) 88.57
Adjusted Stock Price 94.13
TESORODividend Discount Model (DDM) or Fundamental P/E Valuation Model
Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E 2021E
EPS 5.25$ 6.04$ 6.57$ 7.19$ 7.56$ 7.61$
Key Assumptions CV growth 2.00%
CV ROE 8.38%
Cost of Equity 9.99%
Future Cash Flows P/E Multiple (CV Year) 9.52
EPS (CV Year) 7.61
Dividends Per Share 2.10 2.42 2.63 2.88 3.02
Future Stock price 72.49Discount periods 1 2 3 4 5
Discounted Cash Flows 1.91 2.00 1.97 1.97 1.88 48.49
Intrinsic Value 56.30$
Intrinsic Value (Adjusted) 61.13$
TESORORelative Valuation Models
EPS EPSTicker Company Price 2016E 2017E P/E 16 P/E 17
VLO Valero Energy Corporatio $58.60 $3.60 $5.32 16.3 11.0
MPC Marathon Petroleum Cor $42.82 $2.21 $3.35 19.4 12.8
HFC HollyFrontier Corp $23.84 $0.69 $1.97 34.6 12.1
PSX Phillips 66 $80.13 $3.30 $5.48 24.3 14.6
WNR Western Refining Inc. $28.82 $1.37 $1.74 21.0 16.6 Average 23.1 13.4
TSO TESORO $85.48 $5.25 $6.04 16.3 14.1
Implied Value: Relative P/E (EPS16) $ 121.23 Relative P/E (EPS17) 81.06$
As of 11/14/16
TESOROKey Management Ratios
Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E
Liquidity RatiosCurrent Ratio (CA/CL) 1.56 1.46 1.70 2.09 2.05 2.19 2.23 2.28 2.34
Quick Ratio (CA‐Inventories)/CL 0.81 0.76 0.79 1.31 1.28 1.37 1.42 1.48 1.53
Cash Ratio (Cash +Short Term Investments)/CL 0.36 0.29 0.37 0.88 0.85 0.94 0.98 1.05 1.10
Activity or Asset‐Management RatiosReceivables Turnover (Sales/2Year Avg Accts Rec.) 29.69 29.55 25.72 30.95 34.56 33.29 33.34 32.69 32.92
Inventory Turnover (COGS/2Year Avg of Inv) 13.99 15.81 10.84 13.09 13.12 12.57 13.02 12.94 12.90
Total Asset Turnover (Sales/Total Assets) 2.81 2.45 1.75 1.44 1.67 1.70 1.76 1.78 1.81
Financial Leverage RatiosDebt Ratio (Total Liabilities/Total Assets) 0.59 0.58 0.53 0.52 0.54 0.54 0.54 0.54 0.53
Debt to Equity (Total Debt/Total Equity) 0.516 0.611 0.526 0.573 0.584 0.594 0.578 0.564 0.551
Interest Coverage Ratio (EBIT/Int Exp) 4.85 6.35 11.47 5.47 5.50 5.56 5.59 5.65 5.53
Profitability RatiosGross Profit Margin (NI/Sales) 1.10% 2.08% 5.38% 2.57% 2.36% 2.35% 2.36% 2.30% 2.15%
Operation Margin (Operating Income/Sales) 2.56% 2.89% 9.05% 5.12% 4.70% 4.47% 4.33% 4.40% 4.21%
ROA (NI/Total Assets) 3.08% 5.08% 9.43% 3.72% 3.95% 4.01% 4.14% 4.10% 3.90%
ROE (NI/Total Equity) 7.51% 12.08% 19.90% 7.79% 8.51% 8.72% 8.98% 8.84% 8.38%
Payout Policy RatiosPayout Ratio (Dividends Per Share/EPS) 28.99% 16.77% 14.80% 40% 40% 40% 40% 40% 40%
Total Payout Ratio (Dividends+Repurchases of CS)/NI ‐0.46 ‐0.37 0.45 70% 55% 55% 54% 54% 55%
Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding
Number of Options Outstanding (shares): 0.807
Average Time to Maturity (years): 1.526
Expected Annual Number of Options Exercised: 0.529
Current Average Strike Price: 20.34$
Cost of Equity: 9.99%
Current Stock Price: $85.48
2016E 2017E 2018E 2019E 2020E 2021E
Increase in Shares Outstanding: 1 1 1 0 0 0
Average Strike Price: 20.34$ 20.34$ 20.34$ 20.34$ 20.34$ 20.34$
Increase in Common Stock Account: 11 11 11 ‐ ‐ ‐
Change in Treasury Stock 191 110 116 121 127 134
Expected Price of Repurchased Shares: 85.48$ 94.02$ 103.42$ 113.75$ 125.11$ 137.62$
Number of Shares Repurchased: 2 1 1 1 1 1
Shares Outstanding (beginning of the year) 123 121 121 120 119 118
Plus: Shares Issued Through ESOP 1 1 1 0 0 0
Less: Shares Repurchased in Treasury 2 1 1 1 1 1
Shares Outstanding (end of the year) 121 121 120 119 118 117
VALUATION OF OPTIONS GRANTED IN ESOP
Ticker Symbol TSO
Current Stock Price 85.48
Risk Free Rate 2.48%
Current Dividend Yield 2.69%
Annualized St. Dev. of Stock Returns 37.68%
Average Average B‐S Value
Range of Number Exercise Remaining Option of Options
Outstanding Options of Shares Price Life (yrs) Price Granted
Range 1 0.344 26.55 3 49.45 17$
Range 2 0.46 15.72 0.43 65.50$ 30$
Total 1 20.34$ 1.53 62.42$ 47$
