Tesoro Analyst Report-Final (1)

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Krause Fund Research Fall 2015

Energy Recommendation: HOLD Analysts

Landon Kowalski [email protected]

Matt Loochtan [email protected]

Company Overview Tesoro Corporation (TSO) is a nation leading refiner and marketer of petroleum products. Their expertise is refining crude oil into fuel necessary for transportation, such as gasoline, jet fuel, diesel fuel, as well as a few other smaller grade products. Tesoro’s operations include six refineries across the United States that produce a combined 850,000 barrels per day. Their products are sold in 17 states through commercial, retail, and wholesale avenues. Revenue for the fiscal year ended December 31st, 2014 was at $40.63 billion, an increase from $37.6B the year prior. Stock Performance Highlights 52-week High $116.89 52-week Low $64.16 Beta Value 1.56 Average Daily Volume 2.54 m Share Highlights Market Capitalization $13.44 b Shares Outstanding 1.204 b Book Value per share $43.84 EPS (as of FYE 12/31/14) $6.94 P/E Ratio 8.65 Dividend Yield 2.17% Dividend Payout Ratio 14.25% Company Performance Highlights ROA 12.40% ROE 25.74% Sales $40.61 b Financial Ratios Current Ratio 1.63 Debt to Equity 95.64%

Tesoro Corp. (NYSE: TSO)

November 14, 2015

Current Price $111.66 Target Price $120.29

TSO Exhibits Growth Limitations

Tesoro’s sales have sky rocketed the past couple years, along with their stock price. Their impressive growth will not be sustained as they approach their crude oil refining capacity of 850 mbpd. We forecast much smaller growth for the years ahead. We expect oil prices to make a slow recovery, so the outlook for the oil refining and marketing industry is not as strong because costs will increase and profit margins may decrease. Tesoro makes third party purchases of refined products to meet demand requirements for their retailers. If these purchases were to increase because they are not able to produce enough, profit margins would be negatively impacted. We expect an increase in interest rates in December, which would negatively impact Tesoro because they carry an above average level of debt for the industry. Financing costs would increase and we foresee investors reducing exposure to stocks. One Year Stock Performance

Source: amigobullsxvii

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Overview There are many economic factors that drive the energy sector, chief among them are crude oil prices and interest rates. However, within the drivers of crude oil prices are still more factors such as demand for oil and supply of oil. For our economic outlook, we have broken down the indicators that drive crude oil prices and have extensively covered these “sub-drivers” since the energy sector is essentially commodity based. Oil Demand from OECD and Non-OECD Countries Demand for oil is driven by global economic growth in both developed countries (OECD) and developing and emerging countries (Non-OECD). Consequently, world oil demand has been fairly correlated with Real GDP growth, rising between 1-2% annually.i

Source: EIAii Above is a graph charting the consumption of all liquid fuels (i.e. oil, LNG, gasoline, etc.) against WTI prices and world GDP growth. Between Non-OECD and OECD countries, growth in oil demand is strongest in developing and emerging countries (Non-OECD). These countries tend to rely extensively on manufacturing versus services and thus demand more energy for consumption. According to the Energy Information Administration (EIA), OECD demand for oil actually declined between 2000 and 2010.ii However, growth in oil demand in countries such as China, India, and Saudi Arabia, as well as other Non-OECD nations increased by 40% over that period of time.ii Future growth in world oil demand will likely stem from these developing nations and have a larger influence on oil prices over the next few decades. However, when taking into account China’s lackluster growth and projected growth rates, oil demand will have to stem from either a pickup in Chinese growth and/or a shift towards Indochina countries in the near future. In addition, oil prices will likely recover at a slower pace for 2015 and 2016 as evidenced by

the EIA estimates provided below. World oil prices are likely to recover from $41.55 bbl to $49 bbl by the end of 2015 and $51 bbl by 2016.ii We estimate 2017 and 2018 oil per barrel prices to be $60 and $70 bbl, respectively, eventually stabilizing around $75-80 bbl by 2019, with marginal growth in our CV year of 2020. This recovery will be driven by a combination of higher demand from these developing countries and a weakening of supply output in North America, which will be discussed in the Supply of OECD and Non-OECD Countries section. GDP Growth OECD GDP growth rates have been forecasted at 2%, 2.2%, and 2.3% for 2015, 2016, and 2017, respectively.iii The United States has forecasted GDP growth rates of 2.4%, 2.5%, and 2.4% for the same time period above.iii We believe these estimates are reasonable considering the mature economies of most OECD participants as well as troubling indicators in regards to deflationary pressure in Europe and general lackluster growth. For these reasons, we do not foresee a return to 3.5% GDP growth for at least the next 5 years, and instead forecast stable GDP growth at 2.75% for our CV year. We focused on China, India, and Indonesia’s GDP growth rates since we believe the main sources of oil demand growth will be derived by these three nations and their general geographic areas. China’s GDP growth estimates are 6.8%, 6.5%, and 6.2%, for 2015, 2016, and 2017, respectively.iii However, these GDP growth estimates are in line with the Chinese governments reported forecasts and we believe that these growth estimates are over-inflated. Capital Economics, Citibank, Conference Board, and Lombard Street have put the forward growth rates at about 3.8% to 4.9% for the next 5 years.iv The declining forecasted GDP growth rates provide insight into China’s sluggish demand and are partly responsible for the decline in oil prices since 2014. India’s GDP growth rates are forecasted at 7.2%, 7.3%, and 7.4% for the corresponding period above. Indonesia’s GDP growth rates are estimated at 4.7%, 5.2%, and 5.5% for the same period.iv Considering India’s reliance on services over manufacturing as opposed to China’s economic makeup favoring manufacturing, India is positioning itself as a service economy with services making up 57.9% of its current GDP growth.v Thus, we agree with the estimates provided. In regards to Indonesia, their resilient manufacturing growth will be tested by the coming interest rate rise by the United States Federal Reserve, but we believe that the estimates provided have accounted for this uncertainty in its growth rates. The much higher growth rates provided by Non-OECD countries, if realized, will be the main source of world oil consumption growth moving forward and will likely result

Economic Outlook

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in a tightening of oil prices since oil prices rise with higher demand, assuming constant supply. Oil Output of Non-OPEC and OPEC Countries Non-OPEC countries can roughly be seen as OECD countries with the main exceptions being that Russia and Brazil are not participants in OPEC. Non-OPEC countries are currently responsible for producing 60% of the world’s oil production, whereas OPEC is responsible for 40% of production.vi

Source: EIAii Above is a graph charting the production of liquid fuels by Non-OPEC countries against the WTI price of oil. As can be witnessed by the graph, Non-OPEC production has increased dramatically in the last 5 years. The main cause of increase has been the “fracking revolution” in North America. Once uneconomical, shale and oil plays have now become accessible through technological advances that allow unconventional drilling (fracking and oil shale drilling) to be profitable at estimates averaging at or above $65 bbl. The massive growth in North American production has acted as a catalyst for the 43% decline in oil prices since 2014.vii We believe that higher-cost producing sub-industries, such as unconventional companies along with off-shore drilling companies will either slow down production or go bankrupt due to lack of free cash flows and high long-term debt payments maturing within the next 2-3 years. In the short-term, however, many of the North American onshore high-cost producers have shut down 60% of their drilling rigs year to date, and have transitioned to low-cost, high-producing oil plays.viii Due to this transition, rig usage declines have yet to cause a significant decrease in oil production. Thus, we believe oil supplies will largely stay bloated for the next 2 years, until these firms run into free cash flow problems.ix

Source: EIAii OPEC oil production is a different story all together. From 2005 to 2015, OPEC has consistently lost market share to North American, Latin American, and Russian oil companies, seeing a decline of 7% from 40% to 33% over that period.xxi In an effort to sustain their current market share, they have decided on a strategy of stable production growth that is contrary to the usual production cuts that OPEC would have taken to prop up oil prices in the world market. This strategy has contributed to the further erosion of oil prices. We believe that OPEC will continue this strategy until it is adequately satisfied that high-cost North American companies will not pose a medium-term threat to its market share in the future. Crude Inventories Crude inventories are an excellent indicator for viewing and forecasting oil demand and supply in the world. When oil inventories build up, either a lack of demand or uneconomical oil prices are usually to blame. In either event, the market tends to react negatively to upward trends in crude inventories whereas a decrease in inventories usually corresponds with growing demand, resulting in higher oil prices. Unfortunately, for the 2015 year, crude inventories have been steadily building up. However, since we have forecasted oil prices to recover largely by 2019, although not to their peak 2014 levels, crude inventories should start to decrease moving forward.

Source: EIAii

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Interest Rates Interest rates can be a positive or a negative for almost every sector, especially for the high-capital intensive energy sector. Most energy companies borrow heavily to both magnify returns and help fund operations. When interest rates are low, borrowing costs, or corporate bond yields, generally drop as a response. Thus, there is a positive correlation between interest rates and corporate bond yields as demonstrated by the graph below.

Source: FREDxii We believe that the Federal Reserve, in light of recent positive economic data, will more than likely raise interest rates in late December 2015 from a low of .25%.xiii We project the Fed Funds Rate will rise to 1% by the end of 2016, Janet Yellen’s goal, and then about 1% increases per year to settle at 4% in 2019-2020. The main effect this rate rise will have on the energy sector is to make refinancing and further debt issuances more costly for borrowers. As we have stated, we believe that higher-cost oil producers such as fracking and tar sand companies will likely go out of business with higher debt and interest repayments, but an interest rate rise will act as a catalyst for this event to happen. When interest rates rise, these companies will have trouble financing their operations and will subsequently either have to issue equity, sell off assets, or file for bankruptcy. In any event, oil production should decrease as more players leave the industry, which further justifies our view that oil prices will rise when supply tightens in the next 2-3 years. Conclusion After taking into account the demand and supply equations that are so prominent in understanding what drives crude prices, and thus, the energy sector, we have concluded that currently, the market is awash in oil supply and demand from China is weak. The result: low oil prices. However, when adjusting our view out 2-3 years, we forecast a pickup in Chinese and Indochina demand as well as a decline in oil production, largely stemming from North American output, to put upward pressure on prices. We believe that these forecasts and assumptions are reasonable and are generally in line with the EIA and other analyst estimates.

Overview Tesoro Corporation operates in the oil, gas, and consumable fuels industry. More specifically, they are a part of the oil refining and marketing sub industry, which focuses primarily on the downstream side of the energy business. Recent Developments and Trends Future Rebound in Oil Prices As previously mentioned, crude oil supply levels have been hitting record highs recently with production outpacing slowing demand. We forecast crude oil prices to rebound slowly the next five years, which will also cause revenues to climb back. Given this industry is the mature stage of its lifecycle; profit margins will most likely remain fairly stable during this period. However, there is a chance for profit margins to slightly decline should the rise in price outpace the rise in demand, which many industry experts are forecasting to happen. Lower profits margins will hurt the industry with lower net incomes and a potential sell off for investors.

Source:IBISWorldxiv Standards and Regulations Further revenue growth in this industry is likely to be hindered by newly enforced regulations by the Environmental Protection Agency (EPA). They will require vehicles manufactured after 2016 to have a higher minimum fuel efficiency of 36 mpg.xiv These regulations combined with the fact that more and more consumers are deciding to purchase hybrid and electric cars will lead to less demand at the pump. Markets and Competition Major integrated oil companies (IOCs) represent the majority of the refining capacity in the US. These companies, such as Exxon Mobile and Royal Dutch Shell, have a competitive advantage with their huge, customer ready retail segments and wide array of refineries. However, these IOCs have really struggled

Industry Outlook

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in other large upstream areas of their business with this huge drop in oil prices. On the other hand, the performance and value in refiners have been increasing as their costs have been very low. This can be seen in the desirable positive year to date returns in the oil refining and marketing industry. Going forward, with oil prices likely to make a smooth recovery, we are not confident this trend will hold as costs will go back up. Success within this smaller group of oil refining specific companies revolves around the ability to have have a direct sales outlet through a large retail network, large enough refining capacity to meet demand if necessary, and low purchase prices of crude to maximize profit margins. The major players in this industry and how they compare are shown in the table below:

Porter’s Five Forces Threat of New Entrants The oil and gas refining and marketing industry has very difficult barriers to entry because of the inability to build new refineries. Laws are in place restricting where refineries can be built because they are extremely undesirable to live near and significantly devalue property. Companies must compete for the refineries already in existence, should they need the extra capacity to grow and fulfill demand requirements. Threat of Substitutes The threat lies in emerging alternative sources of energy as we become more conscious of our impacts on the environment. The large growth in electrically operated vehicles and other fuel alternatives has already started to have an impact on the demand and prices of oil. Should these substitutes continue to grow at a fast pace, it could spell trouble for the refining industry. Power of Suppliers Given that prices of crude oil are market based, suppliers have little power over refineries. Refiners will source out the cheapest price per barrel they could find to keep costs low. The power is very much in the hands of the refining companies because they can negotiate costs and are never committed to one supplier.

Power of Buyers The power of retailers and wholesalers is moderate to low, since market prices are the main determinant. Retailers and wholesalers will search and choose whichever refiner offers them the cheapest prices; however, many retailers are owned by refining companies and, therefore, direct sales outlets. Rivalry Among Competitors Competition is very high among companies in this industry on the basis of price and quality of the product. They compete to purchase the lowest priced crude possible from the suppliers in order to be able to charge lower prices for their final products while maintaining the same profit margin or greater.xiv

Overview: Tesoro is a leading refiner and marketer of petroleum products that has grown substantially the past few years. Tesoro generates revenue mainly through refining, but also has transportation and retail segments that assist in sales. They own six refineries across the United States that produces a combined 850,000 barrels per day. Their products are sold in 17 states through commercial, retail, and wholesale avenues. Revenue for the fiscal year ended December 31st, 2014 was at $40.63 billion, an increase from $37.6B the year prior.

Source: Item 1. 10Kxvi

Products Tesoro refines crude oil to produce four different types of fuels that are eventually sold to their consumers. These products are gasoline, jet fuel, diesel fuel, and heavy fuel oils/residuals and the percentage of total production for each are shown in the chart below.

Company Analysis

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Source: Item 1. 10Kxvi

Note: these are 2014 numbers. Each year production can vary slightly for all segments. Given gasoline is 49% of Tesoro’s output; a large portion of their revenues weighs on the sale of this product. It is vital for gasoline sales to continue to consistently grow into the future to supply Tesoro with growth in revenues and profits. Recent Performance In the third quarter of 2015, Tesoro reported earnings per share of $6.13 beating the consensus estimates of $6.05. The lower cost to obtain crude oil and the widening profit margin drove the higher than expected EPS. Revenues for the quarter were reported as $7.74 billion, which also came in higher than the consensus of $7.1 billion, but are down 30.6% from the prior year’s third quarter. The lower revenues from the year prior were attributable to lower oil prices. Tesoro capitalized on these lower costs by increasing their gross margins from 5.59% to 17.96%xv. The graph below shows a comparison of five-year cumulative returns for Tesoro, the S&P 500, and its peer competitors (Marathon, Phillips, Valero, and HollyFrontier.) The returns for Tesoro have outpaced its industry competitors by 59% the past 5 years.

Source: 10kxvi

Production Tesoro purchases their crude and other feedstock from both domestic and foreign suppliers. As of 2014, oil sourced from domestic and foreign suppliers are 59% and 41% respectively2. As previously mentioned, they refined an average of 825,000 barrels per day (mbpd) in 2014, just

25,000 below capacity. The two California refineries are responsible for the largest amount of volume, which was 523 mbpd in 2014. Second is the Pacific Northwest refineries that refined 171 mbpd total. The mid-continent refineries produce the least amount with a total of 131 mbpd. The table below shows the gross refining margin ($/Throughput barrel) in 2014 for each region:

California $10.76

Pacific Northwest $10.43

Mid-Continent $23.44 Source: Income Statement 10Kxvi

Many companies like to expand or make their current refineries more efficient to increase capacity should capacity limit their growth, such as in Tesoro’s case. Being that their pacific-northwest refineries currently have some of the lowest capacities and the largest profit margin, we believe they will look to increase capacity should they choose to do so. This margin would be extremely advantageous leading to large increases in net income. Distribution channels In 2013, Tesoro acquired a logistics company, capitalizing on the opportunity to significantly cut transportation costs and provide a more efficient way to distribute their products. This midstream division, which is now known as Tesoro Logistics LLC, owns 3,500 miles of pipelines, 28 truck and marine terminals, and over 9 million barrels of storage capacity. This division provides Tesoro with a huge competitive advantage because they have a faster, more cost effective method of delivering their products and increasing customer satisfaction. Competition Tesoro has competition with other major refining companies like Valero, HollyFrontier Corp, Alon USA Energy Inc., and Sunoco. With refined barrels per day for each company at:

Valero 2,900,000

HollyFrontier Corp 443,000

Alon USA 217,000

Sunoco 900,000 Tesoro 850,000

Source: Company’s homepage Tesoro produces the third highest number of barrels per day between companies that only focus on refining and marketing. Producing a smaller amount of barrels per day for Tesoro will ultimately limit their sales. Areas of concern for these companies are not just the price per barrel, but the

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Valuation Analysis

effect of supply and demand. The more consumer demand the more revenue the companies will bring in. Brand awareness is a big competitive factor in marketing to retailers. Volume of production, availability of finished goods, and ease of transportation to the retailers all affect competition. Since Tesoro produces less barrels then Sunoco and Valero, they may lose out on potential deals with bigger retailers due to lack of supply. Dividend Payout Tesoro recently upgraded their dividend to shareholders. They are paying out $2.00 per share each year with this updated release, which puts them above the competitors in payout to investors. Valero pays $1.60 per share, HollyFrontier pays $1.32 per share, and Alon USA pays $.60 per share. Tesoro is confident in their ability to keep generating greater profits and shows appreciation towards investors believing in them as well. Competitive advantage As stated before, Tesoro has their own logistics company TLLP (Tesoro Logistics) that delivers the refined oil to the retailers. The revenues that the logistics partner creates are an extra benefit for Tesoro’s revenue. As of FYE 2014, TLLP saw $600 million in revenues with $206 million in operating income, giving Tesoro a boost of about $400 million in realized profits. In general, Tesoro Logistics charges on a fee-based schedule for gathering, processing, and transporting crude and refined oil for other companies. However, with Tesoro having their own partnership, they are able to save on all the costs usually incurred by their competitors. By carrying out this method, they try to channel to the consumer better and cheaper. Tesoro’s recent expansion into the Basin area of North Dakota allows them to someday pump the oil out of the dense oil fields in which the basin area is located. However, we do not foresee Tesoro making any more big acquisitions or expansions through 2020, which limits Tesoro from growing larger. Catalysts for Growth/Change If oil prices continue to drop slowly or even keep steady for a couple years, Tesoro’s value could see a constant increase. Since Tesoro is a refiner and marketer, the oil prices seems to have very little affect on the oil prices. Tesoro’s growth may take a halt this year as their refining yield is over capacity. The past three years, the yield has gone up on average 150 thousand barrels per day. But as of this year, the refining yield cannot get much higher for the forecasted years to come. The U.S has many government regulations and public concerns for the environment and, therefore, it would be

hard to build a new refinery. The only way to continue growth for Tesoro would be capital spending towards the increase of capacity. S.W.O.T Analysis Strengths Tesoro has a strong presence in the northwestern part of the United States while most competitors are in other locations. Tesoro is also the second largest refinery and marketing company in the United States.

The recent expansion of logistics into the Bakken Formation of North Dakota, Montana, and Canada helps to increase the number of retailers they have readily available. Also, the expansion increases the revenues from the Logistics Partnership that they own. Earnings were unbelievable for Tesoro by more than doubling net income from the previous year at $224 million to $586 million. Weaknesses Tesoro only produces and ships within the United States, which limits connections and opportunities around the world. Massive increase in growth from the past three years are going to sustain themselves and level out to a lower than average rate. Opportunities The Refining and Marketing oil companies have become the only positive trading companies in the oil industry YTD. This situation is due to the decrease in oil prices that is lowering revenues and outlooks for other subsectors. Threats The recent oil price decrease can eventually have an affect on the oil industry as a whole, but has yet to cause too much trouble. Government regulations are becoming more non-refinery friendly because of the push for cleaner air and less harm to our ozone layer and earth. Summary We are issuing a HOLD rating for Tesoro after reviewing the results from our model. We used methods such as enterprise DCF, economic profit, relative valuation, and the dividend discount model to value Tesoro. We calculated a price target of $120, which is only 7.8% shy of where it is trading now, so it doesn’t

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Sensitivity Analysis

provide much room for profits. In essence, the most significant factors of our model are the sales/revenue forecasts, the forecasts for profit margins, Revenue Decomposition Tesoro’s revenues are decomposed into the following three segments: refining, transportation, and retail. The refining segment is responsible for approximately 93.8% of all revenues when taking into account intersegment sales. The major growth limitation is Tesoro’s refining capacity. Unless they are able to acquire more refineries, which we cannot predict, their growth will be extremely limited to non-existent. Refining throughput for 2014 was only 25,000 barrels of crude oil per day below their capacity, so our forecast shows little growth. Operating at full capacity day in and day out is not realistic due to unforeseeable circumstances, so we had to take that into consideration as well. Product sales growth could still outpace changes in production if Tesoro decides to increase third party purchases to meet demand requirements. Although the boost in the products sales leads to higher revenues, these sales would be on lower profit margins providing Tesoro with miniscule increases to net income or even decreases. WACC We calculated Tesoro’s WACC to be 6.94%. We used the yield to maturity on the 30-year U.S. Treasury bond to calculate our risk free rate at 2.9%. Also used the U.S. geometrical average as the market risk premium of 4.62%. Tesoro’s beta was calculated by averaging different time frames, and averaged 1.168. This high beta means Tesoro is more volatile than the actual market. With this information we were able to calculate the cost of equity and cost of debt of 8.3% and 3.9% respectively from our CAPM model. DCF/EP Model We believe the DCF model delivers the most accurate estimates for our intrinsic price value because of our changing FCF, and our small CV growth rate. We chose a growth rate of 0.5% after 2020 due to the mature lifecycle that the oil refineries are in. The DCF model produced an intrinsic price per share value of $120.35. We have strong beliefs that Tesoro should trade at this price due to positive FCF on hand. After FYE 2017 we expect a positive return on FCF due to a strong increase in invested capital. Relative Valuation Models We chose to include smaller direct competitors to Tesoro that had similar EPS or P/E ratio for 2015. The average P/E

ratio for its competitors in 2015 and 2016 came to be $14.4 and $15.3, respectively. While in the same years Tesoro produced P/E ratios of $13.1 and $28.3, respectively. Due to drop in EPS for 2016 by 54% or $4.56 the outlook for relative P/E in 2016 is substantially increased. All the calculations came out to an intrinsic price of $122.40. It shows that Tesoro trades at a premium compared to other companies in the forecasted model. DDM Model The DDM model came up with a little bit lower price than the other models had given us, at an adjusted price of $96.96, on November 15, 2015. This number was mainly based on our ROE of 13.55% and our CV EPS of $10. This model expects dividends to keep increasing through CV date due to the consistent increase Tesoro has had in dividends each year. It is still difficult to predict future dividends, therefore, predicting future price using this model can still be unclear. Sensitivity analysis becomes an important part of valuation with the DCF/EP model due to the nature of small changes having big affects on a company’s value. CV ROIC vs. WACC Since we use the DCF model to ultimately make our decision about our intrinsic price it is important to understand how each variable can affect our price. These two are important in estimating our future cash flows. A 1% increase in the WACC will lead to an increase in price of $17.59, or 15% of the original value. However, a decrease by the same percent leads to a decrease in price of $15.12, or 13%. When the ROIC changes in our table it has a less of affect in a price change. With 1 percent change higher and lower the equivalent price change becomes 0.5% and -0.07% respectively. The ROIC is reliant on the consistency of a company’s NOPLAT and beginning invested Capital. If NOPLAT continues to rise as beginning invested capital lowers, the chain affect is a higher ROIC and a more valued company. Tesoro is expected to increase their value due to the predicted CV ROIC to stay above the WACC for the upcoming years.

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Beta vs. Market risk Premium The beta and market risk premium table shows how companies fluctuate based on relativity to the market and common risk rates. If Tesoro were to be completely correlated with the market it would have an increased stock price. Also the higher market risk premium is the lower the stock price would be and vice versa for lower risk premium. With each decrease in beta of .1 the stock seems to increase to 7%. This is due to less risk associated with higher correlation in market risk. Since Tesoro on average has beaten the S&P for yearly returns, the risk associated with Tesoro is at a premium from that of the S&P.

CV growth of EPS vs. Cost of Debt Due to the already use of maximum capacity that Tesoro has in 2014, this restricts more growth than at the present time. Having predicted a lower growth rate for EPS has a big affect on intrinsic stock price. Increasing the CV growth rate by 150 basis points would grow the intrinsic stock $18.63 higher. This affects our DCF model intuitively due to the more growth a company has the higher it would be valued at. Cost of debt is a big factor in increasing and decreasing the WACC. With an increase in 50 basis points of cost of debt our stock price decreases by 2.5% and a decrease of the same number increases price by 2.6%.

Market Risk Premium vs. Risk Free Rate With Interest rates at record lows right now, the correlated risk free rate is also very low. But as the Fed talks about hiking interest within the next year it is imperative for the risk free rate to increase as well. Due to a high debt to equity ratio that Tesoro takes on the interest rate spike would have a daunting affect on its earnings. Either they have to lower their D/E or the interest rates are going to lower the intrinsic price of the company. The rate increase will deliberately lower our valuation price because of the 95.64% of D/E that Tesoro utilizes.

WACC

$120.29 5.53% 6.03% 6.53% 7.03% 7.53% 8.03% 8.53% 9.03%

8.74% 181.08$ 156.23$ 135.56$ 118.10$ 103.18$ 90.28$ 79.03$ 69.13$

9.24% 181.80$ 156.87$ 136.13$ 118.62$ 103.65$ 90.71$ 79.42$ 69.49$

9.74% 182.45$ 157.44$ 136.64$ 119.08$ 104.07$ 91.09$ 79.77$ 69.82$

10.24% 183.03$ 157.96$ 137.11$ 119.50$ 104.45$ 91.44$ 80.09$ 70.11$

10.74% 183.56$ 158.43$ 137.53$ 119.88$ 104.79$ 91.75$ 80.38$ 70.37$

11.24% 184.04$ 158.85$ 137.91$ 120.22$ 105.10$ 92.04$ 80.64$ 70.61$

11.74% 184.48$ 159.24$ 138.26$ 120.54$ 105.39$ 92.30$ 80.88$ 70.83$

12.24% 184.88$ 159.60$ 138.58$ 120.83$ 105.65$ 92.54$ 81.10$ 71.03$

12.74% 185.25$ 159.93$ 138.87$ 121.10$ 105.90$ 92.76$ 81.30$ 71.22$

13.24% 185.60$ 160.24$ 139.15$ 121.34$ 106.12$ 92.96$ 81.49$ 71.39$

13.74% 185.91$ 160.52$ 139.40$ 121.57$ 106.33$ 93.15$ 81.66$ 71.55$

CV ROIC

Beta

120.29 0.668 0.768 0.868 0.968 1.068 1.168 1.268 1.368 1.468

3.42% 224.48 208.11 193.40 180.10 168.01 156.98 146.87 137.57 128.98

3.82% 211.54 194.83 179.90 166.49 154.38 143.37 133.34 124.14 115.69

4.22% 199.65 182.70 167.66 154.22 142.14 131.22 121.29 112.24 103.94

4.62% 188.68 171.58 156.50 143.09 131.09 120.29 110.51 101.61 93.48

5.02% 178.52 161.35 146.28 132.95 121.06 110.40 100.78 92.05 84.10

5.42% 169.09 151.90 136.89 123.66 111.92 101.42 91.97 83.42 75.64

5.82% 160.32 143.15 128.23 115.14 103.55 93.21 83.94 75.57 67.98

6.22% 152.13 135.03 120.22 107.28 95.85 85.70 76.60 68.41 60.99

Market Risk Premium

CV growth of EPS

120.29 ‐1.50% ‐1% ‐0.50% 0% 0.50% 1% 1.50% 2% 2.50%

3% 120.10 124.15 128.79 134.16 140.42 147.84 156.77 167.71 181.43

4% 114.96 118.62 122.79 127.58 133.17 139.74 147.59 157.13 168.98

5% 110.15 113.45 117.20 121.50 126.47 132.30 139.23 147.58 157.87

6% 105.63 108.61 111.99 115.84 120.29 125.47 131.59 138.92 147.88

7% 101.38 104.07 107.11 110.57 114.54 119.15 124.57 131.02 138.84

8% 97.37 99.80 102.53 105.63 109.19 113.29 118.10 123.78 130.63

9% 93.57 95.76 98.22 101.01 104.19 107.85 112.11 117.13 123.13

Cost of Debt

Risk Free Rate

120.29 2.50% 2.60% 2.70% 2.80% 2.90% 3.00% 3.10% 3.20% 3.30%

3.42% 169.98 166.60 163.31 160.10 156.98 153.93 150.96 148.06 145.24

3.82% 154.92 151.93 149.01 146.16 143.37 140.66 138.01 135.42 132.89

4.22% 141.54 138.87 136.26 133.71 131.22 128.78 126.40 124.07 121.79

4.62% 129.57 127.17 124.83 122.53 120.29 118.09 115.93 113.83 111.76

5.02% 118.80 116.64 114.51 112.44 110.40 108.41 106.45 104.54 102.66

5.42% 109.06 107.09 105.16 103.27 101.42 99.60 97.82 96.07 94.35

5.82% 100.19 98.40 96.64 94.91 93.21 91.55 89.92 88.31 86.74

6.22% 92.09 90.45 88.84 87.25 85.70 84.17 82.66 81.19 79.74

Market risk Premium

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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.

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i Azelton, A. (2009). Fisher Investments on energy. Hoboken, N.J.: John Wiley & Sons. ii U.S. Energy Information Administration - EIA - Independent Statistics and Analysis. (n.d.). Retrieved November 15, 2015, from http://www.eia.gov/ iiiOECD.org. (n.d.). Retrieved November 16, 2015, from http://www.oecd.org/ iv Manger, M. (n.d.). China's True Growth Is a Mystery; Economists Weigh the Clues. Retrieved November 15, 2015, from http://www.wsj.com/articles/chinas-true-growth-is-a-mysteryeconomists-weigh-the-clues-1430071125 v Central Intelligence Agency. (2014). In The World Factbook. Retrieved from https://www.cia.gov/library/publications/the-world-factbook.html vi U.S. Energy Information Administration - EIA - Independent Statistics and Analysis. (n.d.). Retrieved November 15, 2015, from http://www.eia.gov/finance/markets/supply-opec.cfm vii Tully, S. (2015, January 9). The shale oil revolution is in danger. Retrieved November 15, 2015, from http://fortune.com/2015/01/09/oil-prices-shale-fracking/ viii U.S. Rig Count. (n.d.). Retrieved November 15, 2015, from http://www.aogr.com/web-exclusives/us-rig-count/2015 ix Helman, C. (2015, February 13). Oil Rig Count Continues To Plunge, Down 30 Percent From November. Retrieved November 15, 2015, from http://www.forbes.com/sites/christopherhelman/2015/02/13/oil-rig-count-continues-plunge-down-30-percent-from-november/ x OPEC's perspective on the world oil market. (2005, November 2). Retrieved November 15, 2015, from http://www.opec.org/opec_web/en/882.htm xi Confidential OPEC report sOilfield Services market share squeeze. (2015, November 4). Retrieved

November 15, 2015, from http://www.cnbc.com/2015/11/04/opec-confidential-report-sOilfield Services-market-share-squeeze-to-2019.html xii Board of Governors of the Federal Reserve System (US), Moody's Seasoned Aaa Corporate Bond Yield© [AAA], retrieved from FRED, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/fred2/series/AAA/, November 14, 2015. xiii FED Federal Funds Rate, American central bank's interest rate. (n.d.). Retrieved November 15, 2015, from http://www.global-rates.com/interest-rates/central-banks/central-bank-america/fed-interest-rate.aspx xiv “industry Research Reports." Industry Research Reports. Web. 17 Nov. 2015. IBISWorld.com.Industry-research xv Capitalcube Tesoro-corp-earnings-q3-2015/ Web. 17 Nov. 2015 http://www.capitalcube.com/blog/index.php/tesoro-corp-earnings-q3-2015/ xvi Tesoro 10K xvii "Tesoro Stock Charts (NYSE:TSO)." Tesoro Stock Charts, NYSE:TSO Interactive Stock Chart. Amigobulls. Web. 17 Nov. 2015. http://amigobulls.com/stocks/TSO/stockcharts

Revenue DecompositionTesoro CorporationIn millions

Fiscal Years Ending Dec. 31 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E

Refining Throughput (capacity= 850 mbpd) 517 697 825 829 846 833 837 841 846

Total Product Sales (mbpd)Gasoline 328 343 429 507 512 522 507 512 517 512

Diesel Fuel 130 141 176 206 207 209 207 209 213 220

Jet Fuel 71 76 117 149 152 155 149 154 151 145

Heavy Fuel Oils, Residual Products, and Other 63 67 86 87 87 87 89 89 89 88

Total Sales 592 627 808 949 958 973 951 964 970 964

Product Sales Growth (mbpd)Gasoline 4.57% 25.07% 18.18% 1.00% 2.00% ‐3.00% 1.00% 1.00% ‐1.00%

Diesel Fuel 8.46% 24.82% 17.05% 0.50% 1.00% ‐1.00% 1.00% 2.00% 3.00%

Jet Fuel 7.04% 53.95% 27.35% 2.00% 2.00% ‐4.00% 3.40% ‐2.00% ‐4.00%

Heavy Fuel Oils, Residual Products, and Other 6.35% 28.36% 1.16% ‐0.50% 0.50% 2.00% 0.50% 0.00% ‐1.00%

Total Sales 5.91% 28.87% 17.45% 0.91% 1.65% ‐2.28% 1.33% 0.65% ‐0.59%

Refined Product Sales Margin ($/barrel)Average Sales Price $123.64 $118.40 $112.17 $72.00 $64.00 $75.00 $81.00 $86.00 $92.00

Average Cost of Sales $110.94 $109.64 $102.59 $63.00 $54.50 $65.00 $70.00 $74.00 $80.00

Sales Margin $12.70 $8.76 $9.58 $9.00 $9.50 $10.00 $11.00 $12.00 $12.00

Revenues (in millions)Crude Oil Resales $890 $1,969 $1,456 $961 $869 $995 $1,089 $1,163 $1,237

TLLP, net of intersegment sales $14 $40 $103 $140 $151 $163 $180 $192 $215

Retail, net of intersegment sales 595 626 958 $802 $872 $867 $792 $849 $975

Other Revenues 1499 2635 2517 1903 1892 2025 2061 2204 2427

Refining Revenues (sales x avg sales price x 365) 28296 34919 38854 25167 22739 26039 28496 30450 32383

Total Revenues(Other Revenues+Refining Revenues) 29837 37597 40629 27,070 24,631 28,064 30,557 32,655 34,811

Income StatementTesoro CorporationIn millions

Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E

RevenueRefined Products 28,296 34,919 38,854 25,167 22,739 26,039 28,496 30,450 32,383

Other Revenues 1,499 2,635 2,517 1,903 1,892 2,025 2,061 2,204 2,427

Total Revenues 32,961 37,612 40,607 27,070 24,631 28,064 30,557 32,655 34,811

Costs & ExpensesCOGS excluding D&A 30,505 35,884 38,549 24,363 22,907 26,100 28,112 29,716 31,678

Depreciation & Amortization Expense 445 489 562 556 587 619 649 704 748

Depreciation 295 322 363 366 385 404 424 445 468

Amortization of Intangibles 12 13 17 15 12 14 12 15 18

Amortization of Deferred Charges 138 154 182 175 190 201 213 244 262

SG&A Expense 297 275 323 271 246 281 306 327 348

Total Costs & Expenses 31,247 36,648 39,434 25,190 23,740 26,999 29,067 30,747 32,774

Operating Income 1,714 964 1,173 1,880 891 1,065 1,490 1,908 2,037

Other ExpensesInterest Expense 165 151 235 255 143 169 181 191 203

Unusual Expense ‐ Net 297 136 (502) ‐ ‐ ‐ ‐ ‐ ‐

Total Other Expenses 422 290 (243) 255 143 169 181 191 203

Pretax Income 1,212 680 1,416 1,625 748 896 1,308 1,717 1,834

Income Taxes 442 246 547 569 262 314 458 601 642

Minority Interest 27 42 45 47 50 51 52 54 54

Net Income 743 392 872 1,009 436 531 798 1,062 1,138

Shares Outstanding 137 132 126 121 117 117 116 115 114

Earnings Per Share 5.41$ 2.97$ 6.94$ 8.31$ 3.72$ 4.56$ 6.90$ 9.26$ 10.00$

Dividends per share 0.27$ 0.90$ 1.10$ 1.70$ 2.00$ 2.20$ 2.40$ 3.20$ 3.60$

Balance SheetTesoro CorporationIn millions


AssetsCurrent Assets

Cash & Short‐Term Investments 1,639 1,238 1,000 731 665 758 825 882 940

Receivables, less allowance for doubtful accounts 1,221 1,313 1,435 758 788 842 1,069 1,110 1,288

Inventories 1,578 2,565 2,439 1,624 1,576 1,880 1,803 2,025 2,228

Prepayments and other current assets ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Total Current Assets 4,636 5,326 5,074 3,113 3,030 3,480 3,697 4,017 4,456

Property, Plant & EquipmentProperty, Plant & Equipment, at cost 7,257 9,123 11,633 12,215 12,825 13,467 14,140 14,847 15,589

Accumulated Depreciation 2,012 2,248 2,588 2,687 2,822 2,963 3,111 3,266 3,430

Net Property, Plant & Equipment 5,245 6,875 9,045 9,527 10,004 10,504 11,029 11,581 12,160

Other Noncurrent AssetsAcquired Intangibles, net 214 263 1,222 262 212 240 244 281 278

Other, net 607 925 1,243 821 817 895 963 1,041 1,082

Total Other Noncurrent Assets 821 1,188 2,465 1,083 1,029 1,135 1,207 1,322 1,360

Total Assets 10,702 13,389 16,584 13,723 14,062 15,119 15,933 16,919 17,975

LIABILITIES & SHAREHOLDERS' EQUITYCurrent Liabilities

Accounts Payable 2,213 2,596 2,470 1,895 1,724 1,403 1,222 2,612 1,741

Other Current Liabilities 668 812 996 636 579 842 718 767 1,044

Total Current Liabilities 2,881 3,408 3,466 2,531 2,303 2,245 1,940 3,380 2,785

Deferred Income Taxes 850 1,018 1,098 1,345 1,015 939 987 984 1,191

Other Noncurrent Liabilities 647 655 790 631 574 842 917 761 1,044

Long‐Term Debt 1,587 2,823 4,254 2,745 2,812 3,024 3,187 3,384 3,595

Total Liabilities 5,965 7,904 9,608 7252 6,705 7,049 7,031 8,509 8,615

Shareholders' EquityCommon Equity 1095 1212 1281 1,288 1,295 1,302 1,303 1,303 1,303

Retained Earnings 3649 3940 4642 5,445 5,632 5,907 6,428 7,122 7,851

Treasury Stock (356) (798) (1,320) (1,820) (2,320) (2,456) (2,592) (2,728) (2,864)

Other Appropriated Reserves (137) (52) (149) (109) (109) (109) (109) (109) (109)

Total Shareholders' Equity 4251 4302 4454 4,803 4,498 4,644 5,029 5,588 6,180

Noncontrolling Interest 486 1183 2522 1668 2860 3426 3873 2822 3179

Total Equity 4737 5485 6976 6,470 7,355 8,065 8,895 8,399 9,344

Total Liabilities & Shareholders' Equity 10702 13389 16584 13,723 14,062 15,119 15,933 16,919 17,975

Cash Flow StatementTesoro CorporationIn millions

Fiscal Years Ending Dec. 31 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Net Earnings 507 801 566 278 (140) (29) 563 770 454 888

Depreciation, Depletion & Amortization 186 247 357 401 426 422 417 445 490 562

Deferred Taxes & Investment Tax Credit 77 105 (1) 89 95 9 200 (8) 166 246

Other Funds 26 (40) (1) 95 37 (8) 3 105 (451) (146)

Receivables (190) (143) (360) 410 (387) 208 (365) 48 36 10

Inventories (338) 81 (50) 413 165 (635) (506) 192 (311) 149

Accounts Payable 510 92 845 (998) 450 452 448 (61) 518 (298)

Other Assets/Liabilities (20) (4) (34) 28 17 (34) (71) 94 (43) (47)

Net Operating Cash Flow 758 1,139 1,322 716 663 385 689 1,585 859 1,364

Investing Activities

Capital Expenditures (258) (436) (747) (650) (437) (297) (298) (529) (570) (685)

Acquisitions 0 0 (2,105) 0 0 0 0 (40) (2,237) (2,496)

Sale of Fixed Assets & Businesses 4 6 14 40 1 2 7 0 539 0

Other Investing Activities 0 0 0 0 0 0 0 3 6 9

Net Investing Cash Flow (254) (430) (2,838) (610) (436) (295) (291) (696) (2,577) (3,172)

Financing Activities

Proceeds from Stock Options 30 12 9 5 4 5 12 0 72 19

Proceeds from Sale of Stock 0 0 0 0 0 0 288 205 702 949

Repurchase of Common & Preferred Stk. (15) (151) (4) (5) (2) (2) (101) (131) (446) (500)

Cash Dividends Paid (14) (27) (48) (55) (49) 0 0 (38) (121) (141)

Issuance of Long-Term Debt 890 0 1,754 5,658 700 216 312 1,436 3,361 2,222

Payments on Long-Term Debt (1,091) (12) (1,156) (5,714) (486) (69) (624) (1,577) (2,174) (820)

Other Uses (76) (2) (12) (1) (3) (8) (46) (53) (89) (179)

Excess Tax Benefits 27 17 10 3 2 3 13 8 12 20

Net Financing Cash Flow (249) (163) 553 (109) 166 145 (146) (150) 1,317 1,570

Net Change in Cash 255 546 (963) (3) 393 235 252 739 (401) (238)

Cash Beginning of Year 440 986 23 20 413 648 900 1,639 1238

Cash End of Year 440 986 23 20 413 648 900 1,639 1,238 1,000

Operating Activities

Forecast Cash Flow StatementTesoro CorporationIn millions

Fiscal Years Ending Dec. 31 2015E 2016E 2017E 2018E 2019E 2020E

Cash Flows from Operating ActivitiesNet income 1,009 422 531 798 1,062 1,138

Adjustments for Non‐Cash Operating Expenses

Depreciation & Amortization 556 587 619 649 704 748

Change in working capital

Less: Increase to Receivables (677) 30 54 228 41 178

Less: Increase in Inventories (815) (48) 304 (77) 222 203

Less: increase in Prepayments 0 0 0 0 0 0

Increase in Accounts Payable (575) (171) (321) (181) 1,390 (872)

Increase in Other Current Liabilities (360) (57) 263 (124) 49 277

Increase in Deferred taxes 247 (330) (77) 48 (3) 207

Increase in Other Noncurrent Liabilities (159) (57) 268 75 (156) 283Net cash flows provided by operating activitie 2,210 412 926 1,116 2,785 1,400

Cash Flows from Investing ActivitiesIncrease in Short Term investments (269) (66) 93 67 57 58

Capital Expenditures (215) (226) (237) (249) (262) (1,210)

Other Assets (422) (4) 78 68 78 41Net Cash used for Investing Activities (907) (296) (66) (114) (126) (1,111)

Cash Flows from Financing ActivitiesPayment of dividends 206 235 257 278 367 410

Proceeds from issuance of common stock 7 7 7 1 0 0

Repurchases of Common Stock (500) (500) (136) (136) (136) (136)

Change in Long-Term Debt (1,509) 68 211 163 197 211Net cash provided by financing activities (1,796) (190) 339 305 428 485

Net increase(decrease) in cash (492) (74) 1,199 1,307 3,087 774

Cash Beginning of Year 1,000 508 434 1,633 2,940 6,027

Cash End of Year 508 434 1,633 2,940 6,027 6,801

Common Size Income StatementTesoro Corporation


RevenueRefined Products 85.85% 92.84% 95.68% 92.97% 92.32% 92.78% 93.26% 93.25% 93.03%

Other Revenues 14.15% 7.16% 4.32% 7.03% 7.68% 7.22% 6.74% 6.75% 6.97%

Total Revenues 100% 100% 100% 100% 100% 100% 100% 100% 100%

Costs & ExpensesCOGS excluding D&A 92.55% 95.41% 94.93% 90.00% 93.00% 93.00% 92.00% 91.00% 91.00%

Depreciation & Amortization Expense 1.35% 1.30% 1.38% 2.06% 2.38% 2.21% 2.12% 2.16% 2.15%

Depreciation 0.89% 0.86% 0.89% 1.35% 1.56% 1.44% 1.39% 1.36% 1.34%

Amortization of Intangibles 0.04% 0.03% 0.04% 0.06% 0.05% 0.05% 0.04% 0.05% 0.05%

Amortization of Deferred Charges 0.42% 0.41% 0.45% 0.65% 0.77% 0.72% 0.70% 0.75% 0.75%

SG&A Expense 0.90% 0.73% 0.80% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00%

Total Costs & Expenses 94.80% 97.44% 97.11% 93.06% 96.38% 96.21% 95.12% 94.16% 94.15%

Operating Income 5.20% 2.56% 2.89% 6.94% 3.62% 3.79% 4.88% 5.84% 5.85%

Other ExpensesInterest Expense 0.50% 0.40% 0.58% 0.94% 0.58% 0.60% 0.59% 0.59% 0.58%

Unusual Expense ‐ Net 0.90% 0.36% ‐1.24% ‐ ‐ ‐ ‐ ‐ ‐

Total Other Expenses 1.28% 0.77% ‐0.60% 0.94% 0.58% 0.60% 0.59% 0.59% 0.58%

Pretax Income 3.68% 1.81% 3.49% 6.00% 3.04% 3.19% 4.28% 5.26% 5.27%

Income Taxes 1.34% 0.65% 1.35% 2.10% 1.06% 1.12% 1.50% 1.84% 1.84%

Minority Interest 0.08% 0.11% 0.11% 0.17% 0.20% 0.18% 0.17% 0.17% 0.16%

Net Income 2.25% 1.04% 2.15% 3.73% 1.77% 1.89% 2.61% 3.25% 3.27%

Shares Outstanding 137 132 126 121 117 117 116 115 114

Earnings Per Share 5.41 2.97 6.94 8.31 3.72 4.56 6.90 9.26 10.00

Dividends per share 0.27 0.90 1.10 1.70 2.00 2.20 2.40 3.20 3.60

Common Size Balance SheetTesoro Corporation


AssetsCurrent Assets

Cash & Short‐Term Investments 4.97% 3.29% 2.46% 2.70% 2.70% 2.70% 2.70% 2.70% 2.70%

Receivables, less allowance for doubtful accounts 3.70% 3.49% 3.53% 2.80% 3.20% 3.00% 3.50% 3.40% 3.70%

Inventories 4.79% 6.82% 6.01% 6.00% 6.40% 6.70% 5.90% 6.20% 6.40%

Prepayments and other current assets ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Total Current Assets 14.07% 14.16% 12.50% 11.50% 12.30% 12.40% 12.10% 12.30% 12.80%

Property, Plant & EquipmentProperty, Plant & Equipment, at cost 22.02% 24.26% 28.65% 45.12% 52.07% 47.99% 46.27% 45.47% 44.78%

Accumulated Depreciation 6.10% 5.98% 6.37% 9.93% 11.46% 10.56% 10.18% 10.00% 9.85%

Net Property, Plant & Equipment 15.91% 18.28% 22.27% 35.20% 40.61% 37.43% 36.09% 35.46% 34.93%

Other Noncurrent AssetsAcquired Intangibles, net 0.65% 0.70% 3.01% 0.97% 0.86% 0.86% 0.80% 0.86% 0.80%

Other, net 1.84% 2.46% 3.06% 3.03% 3.32% 3.19% 3.15% 3.19% 3.11%

Total Other Noncurrent Assets 2.49% 3.16% 6.07% 4.00% 4.18% 4.04% 3.95% 4.05% 3.91%

Total Assets 32.47% 35.60% 40.84% 50.69% 57.09% 53.87% 52.14% 51.81% 51.64%

LIABILITIES & SHAREHOLDERS' EQUITYCurrent Liabilities

Accounts Payable 6.71% 6.90% 6.08% 7.00% 7.00% 5.00% 4.00% 8.00% 5.00%

Other Current Liabilities 2.03% 2.16% 2.45% 2.35% 2.35% 3.00% 2.35% 2.35% 3.00%

Total Current Liabilities 8.74% 9.06% 8.54% 9.35% 9.35% 8.00% 6.35% 10.35% 8.00%

Deferred Income Taxes 2.58% 2.71% 2.70% 4.97% 4.12% 3.34% 3.23% 3.01% 3.42%

Other Noncurrent Liabilities 1.96% 1.74% 1.95% 2.33% 2.33% 3.00% 3.00% 2.33% 3.00%

Long‐Term Debt 4.81% 7.51% 10.48% 10.14% 11.42% 10.77% 10.43% 10.36% 10.33%

Total Liabilities 18.10% 21.01% 23.66% 26.79% 27.22% 25.12% 23.01% 26.06% 24.75%

Shareholders' EquityCommon Equity 3.32% 3.22% 3.15% 4.76% 5.26% 4.64% 4.26% 3.99% 3.74%

Retained Earnings 11.07% 10.48% 11.43% 20.11% 22.86% 21.05% 21.03% 21.81% 22.55%

Treasury Stock ‐1.08% ‐2.12% ‐3.25% ‐6.72% ‐9.42% ‐8.75% ‐8.48% ‐8.35% ‐8.23%

Other Appropriated Reserves ‐0.42% ‐0.14% ‐0.37% ‐0.40% ‐0.44% ‐0.39% ‐0.36% ‐0.33% ‐0.31%

Total Shareholders' Equity 12.90% 11.44% 10.97% 17.74% 18.26% 16.55% 16.46% 17.11% 17.75%

Noncontrolling Interest 1.47% 3.15% 6.21% 6.16% 11.61% 12.21% 12.67% 8.64% 9.13%

Total Equity 14.37% 14.58% 17.18% 23.91% 29.87% 28.76% 29.13% 25.75% 26.89%

Total Liabilities & Shareholders' Equity 32.47% 35.60% 40.84% 50.69% 57.09% 53.87% 52.14% 51.81% 51.64%

Value DriversTesoro CorporationIn millions


Sales 32,961 37,612 40,607 27,070 24,631 28,064 30,557 32,655 34,811

Less: Cost of Sales 30,505 35,884 38,549 24,363 22,907 26,100 28,112 29,716 31,678

Less: SG&A costs 297 275 323 271 246 281 306 327 348

Less: Depreciation 295 322 363 366 385 404 424 445 468

Less: Amortization 150 167 199 190 202 215 225 259 280

Add: Implied Interest of operating leases 54 58 75 83 84 85 86 88 91

EBITA 1,768 1,022 1,248 1,963 975 1,150 1,576 1,996 2,128

Income Tax Provisions 0 0 0 0 0 0 0 0 0

Tax Shield on Operating Leases 19 20 26 29 29 30 30 31 32

Tax Shield on Interest Expense 58 53 82 89 58 59 63 67 71

Less: Tax on interest/investment income 0 0 0 0 0 0 0 0 0

Tax shield on Ammortized Goodwill 0 0 0 0 0 0 0 0 0

Less: Tax non‐operating Income 0 0 0 0 0 0 0 0 0

Tax Shield non‐operating losses 0 0 0 0 0 0 0 0 0

Adjusted Taxes 77 73 108 118 87 89 94 98 103

Change in Deferred Taxes (82) 217 131 (247) 330 77 (48) 3 (207)

NOPLAT 1,609 1,166 1,270 1,597 1,218 1,138 1,434 1,901 1,818

Operating Current Assets 3,223 4,402 4,457 2,788 2,734 3,143 3,331 3,625 4,038

Normal Cash 424 524 583 406 369 421 458 490 522

Accounts Recievable 1,221 1,313 1,435 758 788 842 1,069 1,110 1,288

Inventory 1,578 2,565 2,439 1,624 1,576 1,880 1,803 2,025 2,228

Prepaid Expenses ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Other Operating Current Assets ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Operating Current Liabilties 3,292 3,855 3,885 3,557 3,056 2,659 2,526 3,914 3,249

Accounts Payable 2,213 2,596 2,470 1,895 1,724 1,403 1,222 2,612 1,741

Accrued Expenses 229 241 317 317 317 317 317 317 317

Deferred Revenue ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Income Taxes Payable 850 1,018 1,098 1,345 1,015 939 987 984 1,191

Dividends Payable ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Operating WC (69) 547 572 (769) (322) 484 805 (289) 789

Net PPE 5,245 6,875 9,045 9,527 10,004 10,504 11,029 11,581 12,160

Other LT Operating Assets 1,721 2,149 3,707 2,391 2,403 2,577 2,721 2,912 3,029

Net Intangible Assets 214 263 1,222 262 212 240 244 281 278

PV of operating lease 900 961 1,242 1,308 1,374 1,443 1,515 1,590 1,670

Other Assets 607 925 1,243 821 817 895 963 1,041 1,082

Other LT Operating Liabilities 291 (143) (530) (1,189) (1,746) (1,614) (1,675) (1,967) (1,820)

Warranty Liabiltites 0 0 0 0 0 0 0 0 0

Deferred Revenue 0 0 0 0 0 0 0 0 0

Other Liabilties 291 (143) (530) (1,189) (1,746) (1,614) (1,675) (1,967) (1,820)

Invested Capital 6,606 9,714 13,880 12,339 13,830 15,180 16,230 16,171 17,798

NOPLAT 1,609 1,166 1,270 $1,597 $1,218 $1,138 $1,434 $1,901 $1,818

Beg. Invested Capital 9,714 6,606 9,714 13,880 12,339 13,830 15,180 16,230 16,171

ROIC 16.57% 17.65% 13.08% 11.51% 9.87% 8.23% 9.45% 11.71% 11.24%

FCF 1,582 (1,942) (2,896) 3,139 (273) (212) 384 1,960 1,818

NOPLAT 1,609 1,166 1,270 1,597 1,218 1,138 1,434 1,901 1,818

Change in invested Capital 27 3,108 4,166 (1,541) 1,491 1,349 1,051 (59)

EP 628 701 587 622 351 166 367 760 682

Beginning Invested Capital 6,579 6,606 9,714 13,880 12,339 13,830 15,180 16,230 16,171

ROIC 16.57% 17.65% 13.08% 11.51% 9.87% 8.23% 9.45% 11.71% 11.24%

WACC 7.03% 7.03% 7.03% 7.03% 7.03% 7.03% 7.03% 7.03% 7.03%

Weighted Average Cost of Capital (WACC) EstimationTesoro Corporation

Market Value of Debt 5,496LT debt 4,254

ST debt 0

PV of Operating Leases 1242

Pretax cost of Debt 6.00%

Marginal Tax Rate 35%

After‐Tax Cost of Debt 3.90%

Average Weight of Debt 28.84%

Market Value of Equity 13,559Risk Free Rate 2.90%

Market Premium 4.62%

Beta 1.168

Cost of Equity 8.30%

Average weight of Equity 71.16%

Market Value of Preferred Stock 0

Value of Capital(D+E+PFD) 19,055

WACC 7.03%

DCF/EP ModelsTesoro Corporation

Key Inputs:

CV Growth 0.50%

CV ROIC 11.24%

WACC 7.03%


Fiscal Years Ending Dec. 31 2015E 2016E 2017E 2018E 2019E 2020E

DCF ModelFCF 3,139 ‐ 273 ‐ 212 384 1,960 1,818

CV 26,610

Discount Periods 1 2 3 4 5 5

Discount Factor 1.07 1.15 1.23 1.31 1.40 1.40

Present Value 2,933 238‐ 173‐ 293 1,396 18,948

PV(FCF) 23,158

+ Non‐Operating Assets

Excess Cash & ST Investments 200

‐ Non‐Equity Claims

Total Debt 4,254

PV Operating Leases 1,380

ESOP 46

Pension & Retirement Obligations 844

Minority Interest 2,522

PV (Equity) 14,312

Shares Outstanding 126

Unadjusted Price $113.87

Partial Year Adjustment 1.06

Target Price $120.29

EP ModelBeginning Invested Capital 13,880 12,339 13,830 15,180 16,230 16,171

EP 622 351 166 367 760 682

CV 10,441

Discount Period 1 2 3 4 5 5

Discount Factor 1.07 1.15 1.23 1.31 1.40 1.40

Present Value 581 306 135 280 541 7435

PV(EP) 9,278

Beg Invested Capital 13,880

PV(Operations) 23,158

+ Non‐Operating Assets

Excess Cash & ST Investments 200

‐ Non‐Equity Claims

Total Debt 4,254

PV Operating Leases 1,380

ESOP 46

Pension & Retirement Obligations 844

Minority Interest 2522

PV (Equity) $14,313

Shares Outstanding 126

Unadjusted Price $113.88

Partial Year Adjustment 1.06

Target Price $120.29

DDM Model AssumptionTesoro Corporation

Fiscal Years Ending Dec. 31 2015E 2016E 2017E 2018E 2019E 2020E(CV)

EPS 8.51$ 3.95$ 5.23$ 7.60$ 10.18$ 10.99$

Key Assumptions CV growth 0.50%

CV ROE 10.99%


Future Cash Flows P/E Multiple (CV Year) 12.24

EPS (CV Year) 10.99$

Future Stock Price

Dividends Per Share $1.70 $2.00 $2.20 $2.40 $3.20 $134.54

Number of Periods to Discount 1 2 3 4 5 5

Discounted Cash Flows 1.57 1.71 1.73 1.74 2.15 90.32

Intrinsic Value 99.22$

Partial year Adjustment 1.06$

Target Price 104.81$

Relative P/E ModelsTesoro Corporation

EPS EPS Est. 5yrTicker Company Price 2015E 2016E P/E 15 P/E 16 EPS gr. PEG 15 PEG 16

VLO Valero $65.92 $8.53 $6.85 7.7 9.6 9.9 0.78 0.97

SU Suncor $29.73 $1.04 $1.35 28.6 22.0 0.5 57.17 44.04

SUN Sunoco $33.13 $2.28 $2.52 14.5 13.1 20.2 0.72 0.65

ALJ Alon USA $16.36 $1.42 $0.84 11.5 19.5 24.6 0.47 0.79

HFC Hollyfrontier Company $48.97 $5.14 $4.06 9.5 12.1 18.9 0.50 0.64

Average 14.4 15.3 11.9 9.4

TSO Tesoro Corporation $111.66 $8.51 $3.95 13.1 28.3 0.1 136.2 293.6

Implied Value: Relative P/E (EPS15) $ 122.40 Relative P/E (EPS16) 60.28$ PEG Ratio (EPS15) 9.78$ PEG Ratio (EPS16) 3.58$

Key Management RatiosTesoro Corporation

Fiscal Years Ending Dec. 31 Formulas 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E

Liquidity Ratios

Current Ratio Current Assets/Current Liabilities 1.61 1.56 1.46 1.23 1.32 1.55 1.91 1.19 1.60

Quick Ratio (Cash+A/R+ST investments)/Current Liabilitie 0.99 0.75 0.70 0.59 0.63 0.71 0.98 0.59 0.80

Cash Ratio Cash/Current Liabilities 0.57 0.36 0.29 0.29 0.29 0.34 0.43 0.26 0.34

Activity or Asset‐Management Ratios

Inventory Turnover Cost of Goods Sold/Inventory 19.33 13.99 15.81 15.00 14.53 13.88 15.59 14.68 14.22

Asset Turnover Ratio Revenue/Total Assets 3.08 2.81 2.45 1.97 1.75 1.86 1.92 1.93 1.94

Fixed Asset Turnover Revenue/PPE, net 6.28 5.47 4.49 2.84 2.46 2.67 2.77 2.82 2.86

Financial Leverage Ratios

Debt ratio Total Debt/Total Assets 0.15 0.21 0.26 0.20 0.20 0.20 0.20 0.20 0.20

Interest Coverage Ratio EBITA/Interest Expense 10.39 6.38 4.99 7.37 6.25 6.31 8.21 9.98 10.03

Debt to Equity Ratio Total Debt/Total Equity 0.34 0.51 0.61 0.42 0.38 0.37 0.36 0.40 0.38

Profitability Ratios

Gross Profit Margin Net Income/Sales 2.25% 1.04% 2.15% 3.73% 1.77% 1.89% 2.61% 3.25% 3.27%

Return on Assets Net Income/Average Total Assets 6.94% 2.93% 5.26% 7.35% 3.10% 3.52% 5.01% 6.28% 6.33%

Return on Equity Net Income/Average Total Equity 15.69% 7.15% 12.50% 15.60% 5.93% 6.59% 8.98% 12.64% 12.18%

Payout Policy Ratios

Dividend Payout Ratio Dividend Per Share/Earnings Per Share 0.05 0.30 0.16 0.20 0.54 0.48 0.35 0.35 0.36

Retention Ratio 1‐(Dividends Per Share/Earnings Per Share) 95.01% 69.74% 84.15% 79.54% 46.17% 51.72% 65.23% 65.42% 63.98%

Documents

Tesoro Analyst Report-Final (1)