|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||482||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
|Entry||07/09/2003 01:38 PM|
Hi, nish --
1: Can you explain a bit more how you get to $625MM EBITDA? EBITDA most recently peaked at $278.6MM in 2001.
2: The record of long term value creation looks spotty. Book was at $12.66/share in '97; at year-end 03, it was $13.74. (OK, I carefully selected the end-points; book was also $8.74 in '95 vs. $18.28 in '01, which paints a slightly different picture.)
3: It doesn't look like the retail business contributes much. Are they in this segment for strategic reasons? The Wal-Mart connection may improve things here, obviously.
4: Are the environmental risks at all quantifiable? I believe that there have been recent suits against lead paint manufacturers; could refineries be next for producing leaded gasoline?
5: How risky do you think this is in the short-term? In the 10-K, they say that they require 5-year average margins in order to remain in compliance with their debt covenants: "if this improvement continues and margins remain at or near the five-year average for the remainder of 2003, we believe we will comply with the financial covenants of our senior secured credit facility in 2003".
6: What about Mandatory Environmental Cap-Ex? Could refineries be permanent low-cash generators due to ever-stricter regulation?
|Entry||07/09/2003 03:05 PM|
|Is there a way to estimate what "normalized" capex is?|
At what levels of gross margin (especially in California) do you start worrying about their ability to paydown debt?
Do you have a debt paydown schedule: for example, how much do you expect to be paid down in 2003, 2004 and how much of that will be from operations vs. asset sales?
Is there any way to get a guage on how profitable Golden Eagle has been this quarter (esp. last month when spreads were wide) and any way of estimating what Q3 will look like? Especially given that some Cal. refineries will be coming back online w/ production.
(i agree w/ bowd that the retail is not super-attractive)
Nice writeup. Thanks in advance for the answers.
|Subject||Reply to Bowd|
|Entry||07/09/2003 03:23 PM|
1. The company has changed significantly in size and EBITDA over the last 2 years. So the 2001 EBITDA numbers are not usable to gauge EBITDA in 2003 and beyond. The $625 is a recent company estimate. Its based on the average composite margin over the last 5 years of $9.66.
2. The company has created significant value over the years, but its not reflected in the price due to the leverage issues. As the company delevers, theprice will get to its correct value.
3. Over the last few years they grew retail at a rapid pace and did not manage well for profitability or cash flow. That has changed. Zero growth. Sale of non-core retail outlets and an aggressive focus on generating FCF from retail. Once they get this segment on track and deleveraged the balance sheet they’ll resume growing the Walmart and Tesoro branded stations again.
4. Environmental factors are the hardest to quantify. I think the industry is a critical one – where even small declines in production would have big negative impacts on the economy and I believe congress would act (like they did for Asbestos recently). But this is an area where you’ll have to form your own judgement about what’s likely to occur over the next 2 years.
5. Tesoro refinanced/renegotiated loan terms in Q103 and Q203 as they had healthy cash flows and paid down debt. So the onerous 10K covenants are mostly gone.
6. They expect Capex of under $200 Million on 2003 and about $250 Million in 2004. Company believes that capex at about $250MM/year is sustainable to meet all needs and regulations.
Thanks for the questions.
|Subject||Reply to Jazz|
|Entry||07/09/2003 03:32 PM|
1. $250 MM should be a good number for normalized capex based on the past and what company has said.
2. If EBITDA went below $425 Million, they’d have trouble repaying debt. It would need to be below 2/3 of the 5-year average for an extended period of several quarters for this to occur.
3. Management has only said that they expect to paydown $500 Million by the end of 2003 to get net debt to $1.5 Billion. I think they are comfortable with a 50% ratio and may look at FCF as expansion capital from then on with moderate debt payment.
4. Here’s link to a company that provides refining margin data:
Based on the West Coast Margin graph looks like Q2 margins in CA have been above the 5-year average for the last quarter.
Thanks for the questions.
|Entry||07/09/2003 10:05 PM|
|-- I spoke to IR at the company a few days ago, RE: EBITDA. They indicated $550 is a good number for mid-cycle profitability, which translates to $180 of FCF. Your #s seem a bit more optimistic. Do you think this is the company being conservative?|
|Subject||Reply to Jazz|
|Entry||07/09/2003 10:46 PM|
|The $625MM EDITDA estimate is from a slide Bruce used recently at an investment conference. Mid-cycle averages change every quarter as the 5 year period changes, but I don't think that would account for all of the delta.|
$550M does seem conservative.
|Entry||07/10/2003 01:17 PM|
|1) Based on the "varying environmental and gasoline formulation standards that exist throughout the nation." it sounds like you are saying the oil refining business is local. But just to make sure I understand correctly, is there any danger that an out of state (or out of country) refiner would rejigger their plants to produce the formula required in a particular state if crack spreads got high enough? In other words, what is the price elasticity of supply? Or in other other words, would remote suppliers keep some sort of lid on just how good margins could get once these plants start pushing the limit of 100% capacity utilization?|
2) why do you think this is cheap? do you think the S/D big picture is not yet well understood by the Street, similar to natural gas a few quarters ago?
3) why has refining capacity shrunk in the face of growing demand?
|Entry||07/10/2003 01:56 PM|
Hi, Nish --
Thanks for the dialog.
Given my usual level of ignorance (deep), maybe you could help me out with a bit of industry background. I've looked at refiners in past, but only the way I look at Women's Wear Daily -- if it's not an underwear ad, I just turn the page.
1: " While refining oil may appear to be a terrible commodity business, this is actually a terrific business with a wide and deep moat for Tesoro. There hasn’t been a new refinery built in the United States for well over 2 decades. Infact the number of refineries was about 220 in 1985 and is presently at 150."
When can we expect to start seeing the effects of this moat? Is there something about refining that makes it so that, even after years of consolidation and capacity reductions, the few remaining oligopolists are unable to earn high and steady profits? Maybe technological improvements and economies of scale are outstripping the decline in # of units? Volume will obviously depend on end demand, but I'd expect crack spreads to be less volatile if there was much of a moat. I guess I just don't understand the industry dynamics, and am afraid that refining might be like some other industries (drive-in movies, for instance), where capacity reduction never did much for the remaining players.
2: What drives crack spreads, anyway? When I look at http://www.herold.com/doc/ians.pdf (is this the right one?) all I see is a bunch of jagged lines; why spreads get to where they do is completely opaque to me. Is there reason to believe that crack spreads will remain at or above the 5 year average?
3: Going from $278MM peak EBITDA to $625MM average -- What's changed besides the Golden Eagle acquisition? If the EBITDA increase is mostly attributable to Golden Eagle, it sounds like they got a good deal here.
4: "Management at TSO is terrific." -- they're also not afraid to swing for the fences. At TSO's 52 week low, market cap/debt was about 4%; in other words, the market viewed the company as little more than an out of the money call on crack spreads (obviously, I wish I'd taken some of that call). I'm not saying that the market was right, or that management was wrong to pick up Golden Eagle. But I do wonder two things:
(A) Is this management's standard MO, or was Golden Eagle a once-in-a-lifetime opportunity that justifies taking on some chance of distress?
(B) Is management motivated, personally or financially, to take risks?
5: Could you provide a bit more color on your FCF multiple? Don't pipelines -- which sound like steadier assets than refineries -- sell for 7x? Is there something about refineries that makes them worth more than pipelines, or is my pipeline pricing off-base?
6: At 50% of book for assets that have something like an infinite replacement cost, the company does look pretty cheap.
|Subject||not precisely an oligopoly|
|Entry||07/10/2003 02:23 PM|
|In reply to bowd's question, "Is there something about refining that makes it so that, even after years of consolidation and capacity reductions, the few remaining oligopolists are unable to earn high and steady profits?" I thought I would take a stab at answering this, as I've been studying this industry over the past couple weeks and have decided I'm not yet ready to invest.|
First, some of the key variables which impact refining margins in the short term to intermediate term:
Natural Gas prices (an input to refinery operation)
refinery down time, whether scheduled or not (of competitors)
sour/sweet crude differential (some refiners can use sour crude - the greater the sour discount to sweet, the greater will be the refinery margin for those that can handle it).
weather (winter heating oil)
fuel efficiency in automobiles
competitor actions (note that the majority of refineries are owned by vertically integrated businesses such as Exxon, BP, etc. - they may be differently motivated than independent refiners as other parts of the operation make money while the refineries don't)
foreign refiners (most are incapable of producing gasoline due to environmental regulations in the U.S., and most are unwilling to invest the large capital required to make that work. However I believe heating oil can be more influenced by foreign competition).
Environmental regulation is probably the biggest issue, and the hardest part to get a handle on. Future regulation is unpredictable, as are the associated costs with capital improvement. Investors have been predictiong for several years that refiner margins should really take off (enough to offset the ongoing CapEx required to keep up with changing environmental regulations), but it hasn't yet happened in a big way. The positive of environmental regulation is that every time a expensive set of refinery modifications are required, some refiners elect to shut down rather than upgrade. Some believe that over the next 1.5 years, another 1% of capacity will be taken out from small refiners not willing to upgrade for the new reduced sulfer emmission standards for gasoline.
One of the big factors which can affect refiners is the ability of many factories (end customers) to switch between oil and natural gas. If natural gas prices get too high in relation to oil, then factories switch over to using oil, and vice versa. So the oil and natural gas markets moderate each other, and thus have a big impact on refiners. In fact, I am wondering if the most influencial variable on refiner margins in the past few years has been natural gas. Refinery margins (and capacity utilization) peaked at the time of the CA energy crisis, and they were very low in 2002 when natural gas prices were low.
But, as you can see from my list above, there are many variables, most of which are impossible to predict. If the economy turns really really bad, for example, then capacity utilization is much more likely to fall than rise, and so too will margins. On the other hand, if the stars line up right (a really cold winter, a major refinery or two destroyed by fire or terrorism, a pickup in the economy - all at the same time), it is possible we could see a year unlike any other.
|Entry||07/11/2003 12:13 PM|
|I’ve looked at refiners before (not Tesoro specifically), and came away worried by the simple fact that they are price-takers at both ends of their process. In other words, they cannot control the price of the input (oil), and they cannot control the price of the output (gasoline, heating oil, etc). |
So it seems to me that you have to either (1) have a firm point of view on the direction of commodity prices, or (2) believe that increasing energy demand and decreasing refinery capacity in the USA will give refiners pricing power over their end products.
On the first point, I don’t like to bet on things like commodity prices. On the second, I don’t believe that refiners will ever gain that pricing power. The relative cost of shipping finished product is very low and the USA is importing increasing amounts of gasoline and heating oil. Also, politicians won’t allow refiners to profit at the expense of consumers. This is a hot button issue in several parts of the country.
I haven’t done a ton of work on refiners, and have not looked at them at all recently, but I thought I would share the conclusions I reached in the past. Hope it’s helpful.
|Entry||07/11/2003 01:57 PM|
It appears that with the recent high prices of NG that a lot of folks have switched to distillates. Have you heard much about this? And, if it is true, is TSO a beneficiary of this?? Thanks for the intro to refining.
|Subject||Replies to mpk, bowd et. al.|
|Entry||07/12/2003 03:01 AM|
|Thanks for the questions and comments. Here are my thoughts on them:|
1. Refining in certain areas of the country (e.g. California) is a very unique business. Yes, out of state or country refiners can rejigger plants, but that's costly and it limits the geographies they can sell into.
2. Tesoro is cheap due to the debt overhang. As that goes away, it'll move up.
3. Environmental regulations have driven many refineries out of business.
4. I thought Elan answered Bowd queries very well.
5. Yes, refiners are price takers on both ends, but in states like CA, supply is very constrained. As a few factors move to the benefit of refiners they make out very well. Raw material prices are the same for all players. The key issue is the differential in sweet vs. heavy crude and the crack spead in their respective geographies.
Prices do not need to go to the moon for TSO to do very well.
6. I have no insights into distillate demand vs. NG.
Thanks for the questions and I'm sorry for the delay, but was busy for the last 2 days.
|Subject||TSO vs PCO/VLO|
|Entry||07/12/2003 08:55 PM|
|Thanks for the good write up. |
How do you view PCO and VLO relative to TSO, in terms of investment merits? Are you looking for the most leveraged and w.coast way to play (i.e. TSO) -- or is there something about PCO and VLO you don't like as much fundamentally?
|Subject||Reply to Circa|
|Entry||07/13/2003 02:14 AM|
|I haven't looked at PCO, but looked extensively at VLO and concluded that TSO offered a far better return. TSO would also be considered riskier by analysts, but I think the risk/reward equation is far more favorable with TSO vs. VLO.|
|Subject||CA Crack Spreads|
|Entry||08/19/2003 05:34 PM|
|... are thru the roof... this should be a great quarter for TSO|
|Entry||08/28/2003 03:16 PM|
|I just listened to the call replay. They said 1.6b was the YE03 debt target and it sounded like they'll come in 10-20m high. I assume your 1.5b debt target was net of 100m cash, but it sounds like working capital ate up most of that cash so 1.6b is a pretty valid number for both gross and net debt.|
They said mid-cycle EBITDA is 550m and capex a bit over 200m. Both are lower than your numbers. Perhaps the asset sales explain this, though the impact seems too large. These numbers give mid-cycle FCF of 550 EBITDA - 200 capx - 160 int - 50 tax = 140m, 20m below your base case. Their synergy savings are being eaten up by other costs, so they won't meet their goals in this area. I haven't done the math, but mid-cycle FCF for 2004+ sounds more like 150-180m vs. your 220-270 estimate.
That's still a 25%-ish FCF yield, and if TSO can use the recent high crack spreads to make a bigger dent in the debt it will certainly help give them more breathing room. But if crack spreads dive well below mid-cycle after Labor Day and stay there for a year the FCF would evaporate.