Oil refiner Tesoro's (NYSE:TSO) recent earnings performance illustrates just how tough the refining business is these days. For the 2009 third quarter, Tesoro earned 24 cents a share compared to $1.86 a year ago. So far for the year, profits are 28 cents per diluted share against $1.30 for the same period last year. Despite the falling price for oil, refining margins continue to remain depressed as a result of restricted industrial environment and high unemployment, all of which serve to reduce demand for Tesoro's end products.
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Look at the Bigger Picture
The woes of the refining industry look similar to the situation that occurred earlier this decade when refiners were losing money. Back then, shares in Tesoro got as low as $2 amidst a terrible environment for refiners and the economy. As the economy improved, Tesoro shares traded for over $50. Granted, unemployment never got as high back then because the housing market helped support consumer spending. But at today's price of $13, shares in Tesoro look very attractively priced over the long run.
Shares currently sell for less than 25% of anticipated 2009 revenues and nearly half of stated book value. Yet I would argue that the book value is vastly understated due to the nature of Tesoro's assets and the costs to replace them.
Valuable Assets
No oil refinery has been built in the U.S. for decades. They are extremely expensive, take years to complete and require numerous layers of regulatory approvals. In short, it's very hard to justify building a new refinery today. However, the refining business is extremely valuable to our way of life as it takes oil and turns into gasoline, among other useful end products. And at current share prices, it is far cheaper to buy an existing refiner than attempt to build one out.
The largest refiner, Valero (NYSE:VLO) also trades for less than book. Frontier Oil (NYSE:FTO), with the most attractive balance sheet, currently trades for 1.2 times book value. Many of these names have not traded below book value since 1999 and the lower they go, the more attractive they are becoming. Conservative investors can take comfort in the value of these particular assets. (For more, See Reading The Balance Sheet.)
Patience Is a Virtue
As for when the refining business will turn, that will require some patience. Even oil giant ConocoPhillips' (NYSE:COP) refining segment - one of the largest in the industry - is struggling. However, the refiners are responding to the market. Tesoro indicated that it may operate at 77% capacity in the fourth quarter. As supply comes off the market, prices should stabilize until the market improves enough to handle the unused capacity. (For more, see Oil And Gas Industry Primer.)
The Bottom Line
Patient deep value investors may want to keep a close eye on those refiners trading below book value
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