Tesoro Downgraded to Neutral

We have downgraded independent refiner Tesoro Corporation (TSO - Analyst Report) to Neutral from Outperform despite its impressive third quarter results.

San Antonio, Texas-based Tesoro is an independent refiner and marketer of refined petroleum products in the western U.S. The company operates in two segments: Refining (accounted for 72% of the company’s total 2010 operating income) and Retail (28%).

The Refining segment manufactures and sells gasoline and gasoline-blend stocks, jet fuel, diesel fuel, and other refined products to customers, primarily in the mid-continental and the western U.S. This segment also markets liquefied petroleum gas, petroleum coke, and asphalt.

On November 2, 2011, Tesoro reported outperformed in third-quarter 2011, driven by higher throughput, improved margin environment and solid operational performance. Earnings per share (excluding special items) came in at $2.39, comfortably surpassing the Zacks Consensus Estimate of $1.83 and way above the year-ago adjusted profit of 51 cents. The company reported revenue of $8,101.0 million for the three-month period, up 52.3% from the prior-year figure of $5,320.0 million. The result was 18.2% above our projection.

(Read our full coverage on this earnings report: Tesoro Beats Overall)

Even though Tesoro – which competes in the ‘Oil Refining and Marketing’ industry with firms like Valero Energy Corp. (VLO - Analyst Report) and Western Refining Inc. (WNR - Analyst Report) – has a Zacks #2 Rank (Buy rating) in the short run, we prefer to remain on the sidelines in the longer term.

During the last few quarters, Tesoro has consistently achieved profitable growth that has boosted its stock valuation. In the near term, the company stands to benefit from management’s focus on balance sheet improvement. Additional positives for Tesoro include the scale and diversification benefits afforded by its portfolio of seven refineries.

However, Tesoro remains exposed to the risk of dampened U.S. economic growth and weak product demand. Its lack of geographic diversification and excessive dependence on the West Coast market will further limit the ability to generate positive earnings surprises.

With domestic refining fundamentals remaining weak, we do not see any significant price upside for Tesoro stock in the near-to-medium term, especially since shares have already risen by approximately 30% from the beginning of October. Concern about the overall health of the economy and its impact on product demand is not helping matters either.

Read the full analyst report on VLO

Read the full analyst report on TSO

Read the full analyst report on WNR