Tesoro Beats, Cuts Dividend in Half

Tesoro Corporation’s (TSO - Analyst Report) third-quarter 2009 results came in significantly better than expected, helped by better demand balance in the company’s key West Coast region. Earnings per share came in at 24 cents, against Zacks Consensus Estimate of a penny loss.

Tesoro’s outperformance is in contrast to the steep losses posted by the other major refiners that have already reported -- Valero Energy Corp. (VLO - Analyst Report) and Sunoco Inc. (SUN - Analyst Report).

However, compared to the year-ago period, Tesoro’s earnings per share plunged 87.1%, while sales declined 45.4% to $4.7 billion -- severely hampered by depressed refining margins and lower throughput on the back of weak fuel demand and high inventories.

Refining Segment Results

Tesoro’s refining segment experienced a significant decline in operating income (operating income of $84 million vs. $476 million in the year-earlier quarter) due to struggling profit margins for the production of distillate fuels (like heating oil and diesel), as well as a narrowing of the sweet/sour crude spread.

Throughput

Total refining throughput averaged 564 thousand barrels per day (MBbl/d), compared to 622 MBbl/d in the year-ago quarter. Overall throughput volumes in the California region (consisting of the Golden Eagle and Los Angeles refineries) decreased 13.9% year-over-year to 235 MBbl/d. Throughput in the company’s Pacific Northwest refineries (Alaska and Washington) fell 4.3% year-over-year to 155 MBbl/d, while for the Mid-Pacific (Hawaii) refineries, it was down approximately 8.3% to 66 MBbl/d. In the Mid-Continent region, Tesoro’s refining throughput averaged 108 MBbl/d, 6.1% lower than the previous-year period.

Refining Margins

Gross refining margin decreased 42.5% year-over-year to $9.59 per barrel. In terms of different regions, refining margin was down approximately 36.7% in California to $11.54 per barrel, 34.0% in the Pacific Northwest to $9.08 per barrel, 91.4% in the Mid-Pacific to $1.05 per barrel, and roughly 42.8% in the Mid-Continent to $11.50 per barrel.

Realized Costs & Prices

Manufacturing costs before DD&A decreased 8.6% from the year-earlier level to $4.79 per barrel, primarily due to lower energy costs. Total refined product sales during the quarter averaged 611 MBbl/d, down 10.4% year-over-year. Average price realized on product sales decreased 36.2% year-over-year to $83.71 per barrel. Average cost per barrel was also down 35.1% from the third quarter of 2008 to $76.47 per barrel.

Capital Expenditure & Balance Sheet

Tesoro’s total capital spending (including turnaround expenditure) during the third quarter of 2009 was $109.0 million. As of September 30, 2009, Tesoro had cash on hand of $534 million and long-term debt of approximately $1.8 billion, representing a debt-to-capitalization ratio of 36.2%.

Dividend Cut

Tesoro announced a 50% reduction in its quarterly dividend to 5 cents per share (20 cents per share annualized). The new dividend is payable on December 15, to shareholders of record on December 1, 2009.

Guidance

The company informed that it expects capital spending for 2009 to be less than its stated budget of $600 million. For 2010, the company plans to spend $675 million.

Outlook

We believe that the overall environment for refining margins is likely to remain poor going into 2010. The sharply lower refinery utilization (just over 80% of capacity) provides enough evidence that refineries are cutting back on production because the economy is still struggling on the demand side.

The recent rally in crude prices have added to refiners’ miseries by increasing the cost of oil they buy to make gas, jet fuel and other refined products. Being one of the major U.S. independent oil refiners, Tesoro remains particularly exposed to this unfavorable macro backdrop.

We currently rate Tesoro shares as Neutral. Unless the outlook for refiners improves, we expect the stock to perform in line with the market.

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