Tesoro Corporation (TSO): This Refiner Seems Cheap, Here’s What to Watch For

Tesoro Corporation (NYSE:TSO) is one of the largest refiners and marketers of petroleum products in the U.S., with about 845,000 barrels per day of refining capacity and more than 2,200 retail branded gas stations. Although the company has done very well over the past several years, shares have been on a slump lately, down more than 15% in just the past few months. With Tesoro set to report its second quarter earnings on Thursday, August 1, now seems like a good time to examine whether the fall in Tesoro’s price is a good buying opportunity, or just the first leg of a bigger correction.

A little bit about Tesoro

Tesoro Corporation (NYSE:TSO) is a refiner and marketer of petroleum products, but derives most of its income (over 92%) from its refining operations. The company operates seven refineries in the western U.S. which produce gasoline (47.5%), jet fuel (13.6%), diesel (21.6%) and other products (18.2%).

Tesoro Corporation (NYSE:TSO) has grown primarily through a series of acquisitions, with refining capacity rising from 72,000 barrels per day in the late 1990’s to about 845,000 currently. On the refining side, the most notable recent acquisition was the Carson Refinery from BP plc (ADR) (NYSE:BP), which added 266,000 barrels per day to Tesoro’s refining capacity. On the retail side of the business, Tesoro acquired USA Gasoline in 2007 and the ARCO brand this year.

The numbers: looks cheap, but is it?

At the current share price, Tesoro Corporation (NYSE:TSO) trades for just 10.7 times this year’s expected earnings of $5.14 per share, making it seem relatively cheap. Due to rising revenues, and higher margins due to cost efficiencies resulting from their acquisitions, the company’s earnings are expected to grow pretty rapidly in the coming years. The consensus calls for $6.66 and $7.14 per share in 2014 and 2015, respectively, but what concerns me is the uncertainty surrounding the company’s performance.

For example, in 2014 analysts’ estimates range from a low of $4.42 per share to a high of $8.13, an enormous range. The refining industry is very volatile and its profitability depends on a variety of factors out of the company’s control, so this added risk is reflected in the share price. Also worthy of consideration is Tesoro Corporation (NYSE:TSO)’s excellent financial state, with more cash than debt on the balance sheet, a rarity in the sector. Before we make up our minds on Tesoro one way or the other, let’s take a quick look at what else our investment dollars can buy in the oil sector.

Other options: Valero and Exxon Mobil

Valero Energy Corporation (NYSE:VLO) is an independent refiner, and recently spun off its retail business. The company now makes virtually all of its money from its refining operations, which are massive. Valero owns and operates 15 refineries with a combined capacity of over 2.8 million barrels per day. Unlike Tesoro Corporation (NYSE:TSO), Valero is more geographically diverse in its operations, with refineries on the Gulf Coast, in the Middle U.S., the Western U.S., and the North Atlantic.

Valero Energy Corporation (NYSE:VLO) looks like an absolute bargain on a valuation basis at just 8.1 times this year’s earnings, but there is even more uncertainty regarding the company’s future. 2014 estimates range from $3.22 to $7.53, so the more uncertainty in a company’s future, the cheaper shares are to account for the risk involved. Even so, Valero appears to have a great risk/reward ratio at the current levels.

Speaking of uncertainty, a company that doesn’t have quite so much of it is Exxon Mobil Corporation (NYSE:XOM), which is not only the largest oil company in the world, but is currently the largest company of any kind in the world. Exxon Mobil has a refining/marketing business, but the majority of Exxon’s income is from their exploration and production activities. Exxon is the largest refiner in the world, with almost 5.4 million barrels per day of capacity at their 32 refineries all over the world.

Exxon Mobil Corporation (NYSE:XOM) is expected to earn $7.96 per share this year, which gives us a P/E of 11.8 times this year’s expected earnings. The company is expected to grow its earnings modestly growing forward, but their estimates don’t vary nearly as much as the other two companies.

Final thoughts

It seems that in the oil sector, the valuation of a stock is very dependent on the perceived uncertainty surrounding a company’s future earnings. While I like all three of the companies mentioned here and think that Valero Energy Corporation (NYSE:VLO) actually offers the best risk/reward of the three, you need to use your personal level of risk tolerance to determine which is right for you. Even the “safe” play, Exxon, is anything but boring. In fact, an investment of $100,000 in Exxon Mobil Corporation (NYSE:XOM) 20 years ago would be worth almost $1 million today!

As far as Tesoro Corporation (NYSE:TSO) goes, it seems to be a nice combination of risk and value. During the earnings call, any clarification on where they see the industry heading over the next year or so could provide some degree of clarity to the large range of earnings estimates I mentioned above. For now, any of these three would make an excellent addition to your portfolio.

Matthew Frankel owns shares of ExxonMobil. The Motley Fool has no position in any of the stocks mentioned.

The article This Refiner Seems Cheap, Here’s What to Watch For originally appeared on Fool.com.

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