Tesoro’s second-quarter earnings fell to $238 million from $363 million the year before. Excluding one-time benefits and charges, earnings were $216 million. Operating income slid to $364 million from $644 million a year ago.
Refining operating income registered the bulk of the decline, falling to $395 million from $610 million a year ago, despite the addition of operations from the acquired Carson facility for one month. Turnaround activity and narrowing of midcontinent and Canadian crude discounts were the primary culprits. Given its highly integrated system, Tesoro for the most part avoided the higher cost of RINS during the quarter.
Though the Tesoro Index was flat with the previous year at $15 per barrel, Tesoro’s capture rate fell, leading to a companywide gross margin of $15.42 per barrel compared with $20.96 last year. Operating costs also increased to $5.39 per barrel from $4.87 last year because of the turnaround activity.
Despite the drop in earnings, we continue to see Tesoro’s shares as undervalued and believe it offers one of the more compelling opportunities in the refining space currently as we’ve previously highlighted in our document, The Art of Refinery Valuation and the Industry’s Dividend Growth Potential, on July 24. On valuation, Tesoro continues to trade a discount to our fair value estimate as we think the market is not crediting it for the Carson acquisition and potential profit improvement from running greater amounts of domestic crude. Despite the narrowing of crude differentials we still think Tesoro has a significant long-term opportunity as differentials widen to increase margins at its California facilities by increasing throughput of cost-advantaged domestic crude.
The firm should begin to process greater amounts of discount crude with the start-up of its Port of Vancouver terminal in 2014. Other projects to increase discount black wax crude throughput at its Salt Lake City refinery and to increase distillate yields at its Mandan refinery should lead to higher profitability as well. Finally, as we’ve previously discussed, Tesoro has ample room to increase its dividend. Supporting our thesis, the company increased its regular dividend by 25% to $0.25 per share, implying a forward yield of 1.8%, leaving further room for growth.
Tesoro also has $170 million remaining on its current share repurchase authorization. On a negative note, Tesoro did increase the cost of the Salt Lake City project by $95 million without any increase in its estimated EBITDA contribution of $100 million. As a result, and because of the Carson acquisition, Tesoro revised its 2013 capital expenditure guidance to $690 million.
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