Refining RESURRECTION
Refining RESURRECTION After weathering a debt crisis, Tesoro storms into California—and the future By Joe Bush [email protected]
avid Hackett can be reminded daily of the price of ethical behavior. He merely needs to find a ticker, type in TSO and look through the hands covering his face. That price one morning in midMay was $120 (since dropped because of a May 30 2-for-1 split), and that symbol stands for Tesoro. Hackett, president of energy analysts Stillwater Associates in Irvine, Calif., bought Tesoro shares when they were $3, up from below $2, in 2002. The state of Hawaii, where Tesoro has a refinery and a solid wholesale and retail presence, hired Hackett’s company to study its gasoline price-control law. Not wanting a whiff of conflict of interest, Hackett unloaded his Tesoro stock. “I sold it for $3.25, made 25 cents,” Hackett says.“I was happy. I could have bought it after the Hawaii gig was over, but I didn’t, and I’ve been kicking myself. When it’s a $3 stock, you can buy a lot of shares. I bought a lot of shares.” Tesoro senior vice president and chief economist Lynn Westfall knows the feeling, sort of. “If I’d have been smart at $1.80, I wouldn’t be talking to you now,” he says. The thing is,Westfall was smart then, as was anyone at Tesoro involved with
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changing its business model in the late 1990s from a multifaceted company to a single-focus organization. After using a dangerously high amount of debt to buy refineries, Tesoro executives didn’t
shell and made two acquisitions in California—both closed in 2007—that netted it a Southern California refinery and more than 400 retail sites. With that, Tesoro’s retail network today tops 800 sites on the West Coast, and thoughts of doom several years ago have changed to zoom. Starting in September 2002, Tesoro value went from $2 to $8 in a year, to $30 in two years, to $67 in three. It broke $100 this LYNN WESTFALL Tesoro past March. Revenue more than tripled from $5.2 bilgo near the panic button in the first low- lion in 2001 to $16.6 billion in 2006. margin years of the 21st century. “From 2001 to 2004, the rise in our They kept the reins pulled on expan- price all came from paying down debt,” sion while paying down debt. As the Westfall says.“The jump from the $60s share price and refining margins to where it is today has been accomzoomed, Tesoro burst from a three-year plished because we have been able to
“It was very much a what-doesn’tkill-you-makes-you-stronger kind of thing. It very much focused all of our efforts, and our strategy became very simple: pay down debt.”
tell a growth story.” It’s a tale that deserves some adjectives. “It’s like a moon shot,” says Oppenheimer & Co. senior energy analyst Fadel Gheit, who has followed Tesoro for a decade.“More than remarkable.” Gheit also says, “You live by the sword, you die by the sword.”
Double-Edged Robert V. West founded Tesoro in the 1960s with a $1,000 investment and built it into a Fortune 500 firm before retiring as chairman and CEO in 1992. The company explored and produced oil and gas in the United States, Europe, Canada, Bolivia, Trinidad and Indonesia, and owned a refinery in Alaska and a marine-services business. Bruce Smith, who joined Tesoro from Valero in 1992 and rose to his
Playing Catch-Up
D
ale Ratcliff is in charge of a spread-out chain of 195 c-stores with
years, and almost double-digit [growth] in gross-margin dollars,” says
every footprint imaginable. It’s a young business, and like all youth
Ratcliff. “I’m pretty proud of that.”
it has growing pains and exciting progresses.
Adding to the energy is Tesoro’s purchase of 138 sites from USA
Ratcliff is the general manager of customer satisfaction and
Petroleum this spring (not included in the above number). Most of them
merchandising for Tesoro’s retail division, an official entity for six years.
are in California, and they expand the range of Tesoro footprints to
On paper, there are more than 800 stores under the Tesoro umbrella,
truckstops (Calexico, Calif.). The stores will keep the well-known USA
but most of those are run by jobbers, and Ratcliff has nothing to do
Gasoline brand outside, but Ratcliff and his team get to mold the insides. The hodgepodge of store sizes doesn’t faze Ratcliff; the vast majority
with them. The purview of Ratcliff, a former 7-Eleven and Tosco employee, is
of Tesoro 2Gos were gathered as add-ons to refinery purchases, so the
the 117 Tesoro 2Go locations, and the 78 kiosks attached to the gas
company had little say regarding store specs. The company does an
stations operating under the Mirastar banner in Wal-Mart. Existing
annual quarterly review of all stores, which is attended by Ratcliff,
because of Tesoro’s agreement with Wal-Mart, those sites sell
executive vice president Dan Porter, vice president of retail John Ramsey,
cigarettes, soda and snacks, says Ratcliff. But they’re mostly significant
the general manager of operations, the general manager of construction,
for the leverage they lend to negotiations with vendors and
maintenance and facilities, local regional managers and area managers.
manufacturers.
They study 16 aspects of each site, and the remaining quarters are spent
From his office in Auburn, Wash., Ratcliff gets most animated when talking about the operations of the 2Gos, ranging from kiosks to 3,000 feet, found in Hawaii, Alaska, Utah and Washington. “We have double-digit increases in merchandise sales the last two
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working on recommendations resulting from store visits. Ratcliff says USA 2Go is a possibility but that a certainty is the use of lessons learned in the past six years. “USA never really concentrated on c-store marketing,” he says.
WHAT IT MEANS TO ME Tesoro is one of the largest independent refining companies in the United States,
present position as CEO and president in 1995, has narrowed the company’s focus. In 1998, it bought refineries in Hawaii and Washington, and in 1999 sold its exploration and production assets. In 2001, Tesoro bought refineries in Utah and North Dakota, and in 2002 another, from Valero, in northern California. It sold its marine-services business in 2003. It optimizes its Pacific Rim placements by shuttling feedstock among refineries with its tanker fleet. “We were small upstream and we were small downstream,” says Westfall. “We did an extended strategic analysis and decided we couldn’t afford to fund both ends of the business. We were too small in both and needed to concentrate on one. “We thought it might be easier to grow in refining and marketing for a couple of reasons,” he continues. “We
could see that supply and demand lines would eventually cross, and it looked like refining assets were fairly cheap vs. their earning potential, whereas the capital requirements of the upstream were just huge.” Also sizable is the volatility in the petroleum business, and Tesoro’s acquisition frenzy crossed the lines of post-9/11 upheaval to bring the share price down from the teens. The company’s refinery purchases in 1998 and 2001 were accomplished largely through debt financing, and when jetfuel demand plummeted and a warm winter decreased heating oil demand, Tesoro was nobody’s “treasure,” the Spanish word after which West named the company. “We knew we had to have [Golden Eagle]; we had been looking for a long time for a California refinery,”Westfall
with more than 800 company-operated and jobber/dealership retail sites west of the Mississippi River. Its retail growth is tied to its vertical supply system; most of its 117 Tesoro-branded stores were acquired in refinery purchases. It plans to invest $1 billion over the next five years in its newest refinery in Wilmington, Calif., and to increase that refinery’s production of California-grade gasoline by 20%. The refinery will supply the 278 stations picked up in the refinery purchase, as well as the state’s unbranded market.
says of the following year.“In a perfect world that acquisition would have come several years later, but it didn’t. You have to buy them when they’re available. So there we were with high debt in a bad margin year.” How serious was the company’s sit-
“With our buying staff, I see real opportunities. Using our model of operations and merchandising basics, we can bring those efficiencies to the group.” Ratcliff attributes the growth numbers to the basics he says the chain needs to master before tackling profit centers such as foodservice. The most important basic, he says, is staying in-stock on the best-selling packaged beverages and beer and cigarettes. Instead of having extra SKUs, Ratcliff wants a two-day supply of those categories’ top 20 performers and has configured schematics and layouts to support that model. He says his division does its own ordering—“We’ve had to fight vendors, especially in soft drinks,” he says—and is supplied by McLane. Each 2Go has the 2Go logo and the brand’s colors: red, white and teal. The stores’ proprietary coffee program, called La Java, is through a partnership with Sara Lee. Each region—Pacific Northwest, Hawaii, Alaska, Utah—has its own coffee-area graphics, and Ratcliff says each pot uses more than the average amount of grounds. “We want a good-tasting, first-class presentation of coffee,” he says. Co-branding foodservice is a possibility in the future for 2Gos, says
WHAT’S INSIDE: Tesoro execs call the 2Go concept “corner grocery meets upbeat snack shop.” In 2006, Tesoro’s retail merchandise and other revenues totaled $144 million, while the merchandise margin was 27%. Both numbers increased from 2005. Ratcliff, but for now, limited offerings are the norm. “Before we can build ourselves a niche to be known for, we’ve got to take care of general business,” Ratcliff says. “We haven’t really gotten to that stage of our life yet.”
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Tesoro Corp. Profile Headquarters: San Antonio
uation? According to a story last year in the San Antonio Express News, the company’s debt-to-capitalization ratio was at 60% in the fall of 2001. That rose to 70% after the purchase of the Golden Eagle facility from Valero, which had to sell because it had acquired a larger refinery in the same complex and owning both was not allowed by federal regulators. That’s when the stock reached a low during trading of $1.34 and, according to Wright, the company owed $2.1 billion and had $250 million of revolving credit to its name. Tesoro sometimes paid cash for crude oil for its six refineries because, according to Wright,“as our condition worsened, I could neither borrow nor post letters of credit. It’s not the preferred way to run your business.” The Golden Eagle purchase actually was a significant moment for both companies. For Valero, the lucrative sale price fed the company’s ability to not only grow its refining business but also to pursue an aggressive c-store retail branding strategy that continues today. However, for Tesoro, many respected industry observers predicted the company would fall by the wayside, burdened by unmanageable debt. “They were betting the refining margins would improve,” Gheit recalls. “Not only didn’t the margins improve, they collapsed. It’s like borrowing a lot of money for a heavy mortgage for a house thinking you’re going to get a fat raise. Not only didn’t you get a fat raise, you lost your job.” Working with Bank One (now JP
Assets: Seven refineries yielding approximately 660,000 bpd; 5,000 employees; 464 company-owned retail sites—more than 800 stores total— from kiosks up to 3,000 square feet Key Acquisitions: Refineries in Hawaii and Washington, 1998; refineries in Utah and North Dakota, 2001; refinery in California, 2002; refinery and 278 retail sites in California, 2007; 138 retail sites across three states and USA Gasoline brand, 2007 Income From Retail Segment: In 2004, 538 company-operated and jobber/dealer sites and $6 million loss; in 2005, 494 sites and $31 million loss; in 2006, 465 sites and $21 million loss.
Morgan Chase), Wright secured assetbacked lending and began to pay down debt. For Tesoro, the story was one not so much about growth but of survival. Call it triage, if you will, but Tesoro needed to pare down debt and hope for a rebound in refining margins. And so it happened. Up went the margins and the share price, and Tesoro had itself the start of a recovery and a refinery in the highly prized California market that gelled with its strategic Pacific Rim orientation. Westfall says the company’s brain trust put on a thinking cap instead of a crash helmet; it figured the circumstances—low demand for jet fuel and diesel—were temporary, and with a bit of discipline the company would be all right. “It was very much a what-doesn’t-kill-
“Give them plenty of credit: They didn’t freak out. They didn’t succumb to pressures.” FADEL GHEIT Oppenheimer & Co.
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you-makes-you-stronger kind of thing,” he says.“It very much focused all of our efforts,and our strategy became very simple: pay down debt. So we didn’t grow the business.We put all the maintenance and environmental capital into our refineries that they require.We really hunkered down and concentrated on cash flow and not growth.” Tesoro’s operating income in 2003— its first full year under the new business model—was $335 million, 600% higher than in 1997, and away it went.Westfall says his company’s former situation is not likely to repeat itself, mainly because it used mostly cash for its recent purchases. Temporary dips, such as weather, terrorism or low demand, won’t have the bite they once did. Because the fortunes of petroleumrelated companies are so tied to forces beyond their control, it’s hard not to use the word “luck”—bad or good— when telling their stories. Hackett and Gheit don’t discount it but respect Tesoro’s management. “Bruce Smith gets a little [ticked] off when people say,‘He got lucky,’ ”Hackett says. “They were able to keep it all together and ride out the bad times.” “It’s more luck than brains,” says Gheit. “That’s not disparaging. In this business I’d rather be lucky than smart. “Give them plenty of credit: They didn’t freak out,” he continues. “They didn’t succumb to pressures—‘I will sell out, thank God I’m breaking even, I’m going to get the hell out of this business.’ True refining companies—Valero, Tesoro, Frontier, Sunoco—these are the guys that really had the perseverance, the patience, and felt there would be a light at the end of the tunnel, and they were right. They were rewarded very handsomely.”
Bruce Smith Bio Title: Chairman, president and chief executive officer of Tesoro Corp. Work: Joined Tesoro as CFO in 1992. In 1995 he was named president and CEO and elected to the company’s board of directors. He was named Tesoro’s chairman in 1996. Previously, Smith was vice president and treasurer of Valero Energy Corp. Family: Married, five sons ages 19 to 33. Grew up in Coffeyville, Kan., population 16,000. Hobbies: Golf, skiing, tennis, reading and traveling with his wife and family. Golf handicap: 20. Favorite family vacation: Skiing in Aspen, Colo.
The Spoils California is a quirky state and, like many unique entities, its differences add value. Three factors make it a profitable place to refine oil, all of which involve limited supply and, hence, larger margins: Refiners must produce gasoline that conforms to standards set by the California Air Resources Board (CARB), and neither refining nor importing facilities are easily expanded. Tesoro, like Valero, refines heavy, sour crude, which refiners can buy much cheaper than sweet, more easily refined crude but get the same price and margin once it’s turned into usable gasoline. This crude has been cheaper in California than on the Gulf Coast. The two sets of circumstances converge at the Golden Eagle and Wilmington refineries, where each refines heavy, sour crude. So why in 2006 would Shell sell Wilmington and 278 stations it supplied? Hackett’s opinion is that for 100,000 barrels per day (bpd), the refinery needed more upgrading investment than it was worth to Shell. Shell spokeswoman Alexandra Smith said the move aligned with its
strategy of “more upstream, profitable downstream” and that “at times we are approached by others that have an interest in our assets and who place a value on them that is beyond what we can realize ourselves, given our strategic investment options.”
Not a Retailer? In two strokes, Tesoro increased its refining capacity to 660,000 bpd and set the stage for expansion beyond the retail locations it bought from Shell and USA Petroleum. Before the deals, each of which closed in 2007, Tesoro’s most noticeable presence was as a supplier to wholesalers. There were 13 Tesoro-branded sites in California and six locations under the Mirastar brand (Tesoro’s partnership with Wal-Mart). Now there are approximately 400 more locations that will be run by Tesoro but will keep Shell and USA signage. Both refineries can supply USA sites, while all Shell sites—under contract for years to come—will get Wilmington product. Westfall says retailing is important to Tesoro as an end to a means, and that
“[USA] has a pretty good image, so why spend money? The image is fine and it’s well-known, and you can make your margin whether it’s got your name or somebody else’s.” RON VANDEPOL VanDePol Enterprises
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retail expansion will happen only in range of the company’s refineries. With that in mind, Tesoro will increase its CARB-standard gas production at Wilmington as much as 20,000 bpd in the next year, he says. He says Tesoro has the right to expand the Shell brand in relevant marketing areas and would opt for rebranding open dealers rather than owning sites. “We don’t believe there’s any one formula that’s right,” says Westfall. “Depending on the concentrations of the market, if we can get some economies of scale we don’t mind operating them ourselves. But as you get that dispersal in the market, it’s almost better to have a jobber operate them.” Two men from downstream California welcome Tesoro’s larger presence in their state: Jay McKeeman,vice president of government relations for the California Independent Oil Marketers Association (CIOMA); and Ron VanDePol, president of VanDePol Enterprises,a distributor and marketer out of Stockton. Both say Tesoro is considered a friend of the unbranded market. CIOMA wrote a letter of support for Tesoro’s acquisitions to the California attorney general, while VanDePol’s company has been a Tesoro customer for years. McKeeman says Tesoro won his organization’s support by telling the same story to CIOMA as it had to the Federal Trade Commission—most importantly that there would be plenty of fuel available for the unbranded market after Tesoro supplied the Shell and USA stations. Would independent competitors be squeezed? The guarantee of increased production tipped the scales. “That’s a huge element,” says McKeeman.“Again, we’re not typically fond of
As for the USA stores,VanDePol says if Tesoro can instill in the new stores the customer-service vibe that he gets in his dealings with the company, they can shine. “As long as they allow the operator to upgrade them a little bit, they’ll be fine,” he says.“They’re very friendly and very upfront. If they can pass that on to the USA organization, I think it’s a win for the public.”
Debt-Free
2GO WEST: At the end of 2006, Tesoro boasted 117 company-operated and Tesoro-branded 2Go stores throughout the Western United States. Seventy-seven company-operated stores flew the Mirastar flag on the outlots of Wal-Mart locations.
when refiners take on retail, because obviously they have a better ability to do direct pricing to their service stations and that typically competes with us, especially when unbranded prices are high, branded prices are lower.That’s certainly a thorn in our side.” According to McKeeman, Tesoro won CIOMA’s endorsement by showing it could make the retail acquisitions and still increase the amount of unbranded fuel distributed in the state. Says Westfall of having to satisfy Californians, from the street to the statehouse, “The higher up the chain you go, the more they’re interested just in overall supply growth and less of what 90
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channel it goes into. We were able to demonstrate that [for] virtually every refinery we’ve bought, we have increased the capacity of it.” VanDePol says Tesoro is not “egodriven” as much as it is concerned about throughput, as evidenced by the plan to keep USA and Shell signs on its new sites. It’s a good economic move as well, he says. “[USA] has a pretty good image, so why spend money?” says VanDePol. “Nowadays it costs about $30,000 to $45,000 to reimage a station. The image is fine and it’s well-known, and you can make your margin whether it’s got your name or somebody else’s.”
Here’s how Tesoro has emerged from the debt crisis: Its debt-to-capitalization ratio was 29% at the end of 2006, it had twice as much cash on hand as at the end of 2005, and its 2006 net income was 58% higher than the previous year. Tesoro used cash to pay for one-third of the $1.76-billion deal with Shell. Its record first-quarter 2007 net income was $116 million, or $1.67 per share, more than $1 over the same period in 2006. Its board approved a 2for-1 stock split May 1 and doubled the quarterly cash dividend. As Westfall says, the combination of unanticipated supply and/or demand issues and overextension is unlikely to happen again thanks to its financial status. The former will take place—volatility is the norm—but Tesoro is well-positioned to weather it. “Those are temporary dips, not fundamental changes,” he says.“Fundamental changes would be longer-term—for instance, alternate fuels, ethanol—but that’s nothing that’s going to happen overnight. “We built the company through acquisitions, so we’re always looking to grow, but we’ve gotten to the size where we don’t feel compelled to grow.” ■
avid Hackett can be reminded daily of the price of ethical behavior. He merely needs to find a ticker, type in TSO and look through the hands covering his face. That price one morning in midMay was $120 (since dropped because of a May 30 2-for-1 split), and that symbol stands for Tesoro. Hackett, president of energy analysts Stillwater Associates in Irvine, Calif., bought Tesoro shares when they were $3, up from below $2, in 2002. The state of Hawaii, where Tesoro has a refinery and a solid wholesale and retail presence, hired Hackett’s company to study its gasoline price-control law. Not wanting a whiff of conflict of interest, Hackett unloaded his Tesoro stock. “I sold it for $3.25, made 25 cents,” Hackett says.“I was happy. I could have bought it after the Hawaii gig was over, but I didn’t, and I’ve been kicking myself. When it’s a $3 stock, you can buy a lot of shares. I bought a lot of shares.” Tesoro senior vice president and chief economist Lynn Westfall knows the feeling, sort of. “If I’d have been smart at $1.80, I wouldn’t be talking to you now,” he says. The thing is,Westfall was smart then, as was anyone at Tesoro involved with
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changing its business model in the late 1990s from a multifaceted company to a single-focus organization. After using a dangerously high amount of debt to buy refineries, Tesoro executives didn’t
shell and made two acquisitions in California—both closed in 2007—that netted it a Southern California refinery and more than 400 retail sites. With that, Tesoro’s retail network today tops 800 sites on the West Coast, and thoughts of doom several years ago have changed to zoom. Starting in September 2002, Tesoro value went from $2 to $8 in a year, to $30 in two years, to $67 in three. It broke $100 this LYNN WESTFALL Tesoro past March. Revenue more than tripled from $5.2 bilgo near the panic button in the first low- lion in 2001 to $16.6 billion in 2006. margin years of the 21st century. “From 2001 to 2004, the rise in our They kept the reins pulled on expan- price all came from paying down debt,” sion while paying down debt. As the Westfall says.“The jump from the $60s share price and refining margins to where it is today has been accomzoomed, Tesoro burst from a three-year plished because we have been able to
“It was very much a what-doesn’tkill-you-makes-you-stronger kind of thing. It very much focused all of our efforts, and our strategy became very simple: pay down debt.”
tell a growth story.” It’s a tale that deserves some adjectives. “It’s like a moon shot,” says Oppenheimer & Co. senior energy analyst Fadel Gheit, who has followed Tesoro for a decade.“More than remarkable.” Gheit also says, “You live by the sword, you die by the sword.”
Double-Edged Robert V. West founded Tesoro in the 1960s with a $1,000 investment and built it into a Fortune 500 firm before retiring as chairman and CEO in 1992. The company explored and produced oil and gas in the United States, Europe, Canada, Bolivia, Trinidad and Indonesia, and owned a refinery in Alaska and a marine-services business. Bruce Smith, who joined Tesoro from Valero in 1992 and rose to his
Playing Catch-Up
D
ale Ratcliff is in charge of a spread-out chain of 195 c-stores with
years, and almost double-digit [growth] in gross-margin dollars,” says
every footprint imaginable. It’s a young business, and like all youth
Ratcliff. “I’m pretty proud of that.”
it has growing pains and exciting progresses.
Adding to the energy is Tesoro’s purchase of 138 sites from USA
Ratcliff is the general manager of customer satisfaction and
Petroleum this spring (not included in the above number). Most of them
merchandising for Tesoro’s retail division, an official entity for six years.
are in California, and they expand the range of Tesoro footprints to
On paper, there are more than 800 stores under the Tesoro umbrella,
truckstops (Calexico, Calif.). The stores will keep the well-known USA
but most of those are run by jobbers, and Ratcliff has nothing to do
Gasoline brand outside, but Ratcliff and his team get to mold the insides. The hodgepodge of store sizes doesn’t faze Ratcliff; the vast majority
with them. The purview of Ratcliff, a former 7-Eleven and Tosco employee, is
of Tesoro 2Gos were gathered as add-ons to refinery purchases, so the
the 117 Tesoro 2Go locations, and the 78 kiosks attached to the gas
company had little say regarding store specs. The company does an
stations operating under the Mirastar banner in Wal-Mart. Existing
annual quarterly review of all stores, which is attended by Ratcliff,
because of Tesoro’s agreement with Wal-Mart, those sites sell
executive vice president Dan Porter, vice president of retail John Ramsey,
cigarettes, soda and snacks, says Ratcliff. But they’re mostly significant
the general manager of operations, the general manager of construction,
for the leverage they lend to negotiations with vendors and
maintenance and facilities, local regional managers and area managers.
manufacturers.
They study 16 aspects of each site, and the remaining quarters are spent
From his office in Auburn, Wash., Ratcliff gets most animated when talking about the operations of the 2Gos, ranging from kiosks to 3,000 feet, found in Hawaii, Alaska, Utah and Washington. “We have double-digit increases in merchandise sales the last two
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working on recommendations resulting from store visits. Ratcliff says USA 2Go is a possibility but that a certainty is the use of lessons learned in the past six years. “USA never really concentrated on c-store marketing,” he says.
WHAT IT MEANS TO ME Tesoro is one of the largest independent refining companies in the United States,
present position as CEO and president in 1995, has narrowed the company’s focus. In 1998, it bought refineries in Hawaii and Washington, and in 1999 sold its exploration and production assets. In 2001, Tesoro bought refineries in Utah and North Dakota, and in 2002 another, from Valero, in northern California. It sold its marine-services business in 2003. It optimizes its Pacific Rim placements by shuttling feedstock among refineries with its tanker fleet. “We were small upstream and we were small downstream,” says Westfall. “We did an extended strategic analysis and decided we couldn’t afford to fund both ends of the business. We were too small in both and needed to concentrate on one. “We thought it might be easier to grow in refining and marketing for a couple of reasons,” he continues. “We
could see that supply and demand lines would eventually cross, and it looked like refining assets were fairly cheap vs. their earning potential, whereas the capital requirements of the upstream were just huge.” Also sizable is the volatility in the petroleum business, and Tesoro’s acquisition frenzy crossed the lines of post-9/11 upheaval to bring the share price down from the teens. The company’s refinery purchases in 1998 and 2001 were accomplished largely through debt financing, and when jetfuel demand plummeted and a warm winter decreased heating oil demand, Tesoro was nobody’s “treasure,” the Spanish word after which West named the company. “We knew we had to have [Golden Eagle]; we had been looking for a long time for a California refinery,”Westfall
with more than 800 company-operated and jobber/dealership retail sites west of the Mississippi River. Its retail growth is tied to its vertical supply system; most of its 117 Tesoro-branded stores were acquired in refinery purchases. It plans to invest $1 billion over the next five years in its newest refinery in Wilmington, Calif., and to increase that refinery’s production of California-grade gasoline by 20%. The refinery will supply the 278 stations picked up in the refinery purchase, as well as the state’s unbranded market.
says of the following year.“In a perfect world that acquisition would have come several years later, but it didn’t. You have to buy them when they’re available. So there we were with high debt in a bad margin year.” How serious was the company’s sit-
“With our buying staff, I see real opportunities. Using our model of operations and merchandising basics, we can bring those efficiencies to the group.” Ratcliff attributes the growth numbers to the basics he says the chain needs to master before tackling profit centers such as foodservice. The most important basic, he says, is staying in-stock on the best-selling packaged beverages and beer and cigarettes. Instead of having extra SKUs, Ratcliff wants a two-day supply of those categories’ top 20 performers and has configured schematics and layouts to support that model. He says his division does its own ordering—“We’ve had to fight vendors, especially in soft drinks,” he says—and is supplied by McLane. Each 2Go has the 2Go logo and the brand’s colors: red, white and teal. The stores’ proprietary coffee program, called La Java, is through a partnership with Sara Lee. Each region—Pacific Northwest, Hawaii, Alaska, Utah—has its own coffee-area graphics, and Ratcliff says each pot uses more than the average amount of grounds. “We want a good-tasting, first-class presentation of coffee,” he says. Co-branding foodservice is a possibility in the future for 2Gos, says
WHAT’S INSIDE: Tesoro execs call the 2Go concept “corner grocery meets upbeat snack shop.” In 2006, Tesoro’s retail merchandise and other revenues totaled $144 million, while the merchandise margin was 27%. Both numbers increased from 2005. Ratcliff, but for now, limited offerings are the norm. “Before we can build ourselves a niche to be known for, we’ve got to take care of general business,” Ratcliff says. “We haven’t really gotten to that stage of our life yet.”
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Tesoro Corp. Profile Headquarters: San Antonio
uation? According to a story last year in the San Antonio Express News, the company’s debt-to-capitalization ratio was at 60% in the fall of 2001. That rose to 70% after the purchase of the Golden Eagle facility from Valero, which had to sell because it had acquired a larger refinery in the same complex and owning both was not allowed by federal regulators. That’s when the stock reached a low during trading of $1.34 and, according to Wright, the company owed $2.1 billion and had $250 million of revolving credit to its name. Tesoro sometimes paid cash for crude oil for its six refineries because, according to Wright,“as our condition worsened, I could neither borrow nor post letters of credit. It’s not the preferred way to run your business.” The Golden Eagle purchase actually was a significant moment for both companies. For Valero, the lucrative sale price fed the company’s ability to not only grow its refining business but also to pursue an aggressive c-store retail branding strategy that continues today. However, for Tesoro, many respected industry observers predicted the company would fall by the wayside, burdened by unmanageable debt. “They were betting the refining margins would improve,” Gheit recalls. “Not only didn’t the margins improve, they collapsed. It’s like borrowing a lot of money for a heavy mortgage for a house thinking you’re going to get a fat raise. Not only didn’t you get a fat raise, you lost your job.” Working with Bank One (now JP
Assets: Seven refineries yielding approximately 660,000 bpd; 5,000 employees; 464 company-owned retail sites—more than 800 stores total— from kiosks up to 3,000 square feet Key Acquisitions: Refineries in Hawaii and Washington, 1998; refineries in Utah and North Dakota, 2001; refinery in California, 2002; refinery and 278 retail sites in California, 2007; 138 retail sites across three states and USA Gasoline brand, 2007 Income From Retail Segment: In 2004, 538 company-operated and jobber/dealer sites and $6 million loss; in 2005, 494 sites and $31 million loss; in 2006, 465 sites and $21 million loss.
Morgan Chase), Wright secured assetbacked lending and began to pay down debt. For Tesoro, the story was one not so much about growth but of survival. Call it triage, if you will, but Tesoro needed to pare down debt and hope for a rebound in refining margins. And so it happened. Up went the margins and the share price, and Tesoro had itself the start of a recovery and a refinery in the highly prized California market that gelled with its strategic Pacific Rim orientation. Westfall says the company’s brain trust put on a thinking cap instead of a crash helmet; it figured the circumstances—low demand for jet fuel and diesel—were temporary, and with a bit of discipline the company would be all right. “It was very much a what-doesn’t-kill-
“Give them plenty of credit: They didn’t freak out. They didn’t succumb to pressures.” FADEL GHEIT Oppenheimer & Co.
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you-makes-you-stronger kind of thing,” he says.“It very much focused all of our efforts,and our strategy became very simple: pay down debt. So we didn’t grow the business.We put all the maintenance and environmental capital into our refineries that they require.We really hunkered down and concentrated on cash flow and not growth.” Tesoro’s operating income in 2003— its first full year under the new business model—was $335 million, 600% higher than in 1997, and away it went.Westfall says his company’s former situation is not likely to repeat itself, mainly because it used mostly cash for its recent purchases. Temporary dips, such as weather, terrorism or low demand, won’t have the bite they once did. Because the fortunes of petroleumrelated companies are so tied to forces beyond their control, it’s hard not to use the word “luck”—bad or good— when telling their stories. Hackett and Gheit don’t discount it but respect Tesoro’s management. “Bruce Smith gets a little [ticked] off when people say,‘He got lucky,’ ”Hackett says. “They were able to keep it all together and ride out the bad times.” “It’s more luck than brains,” says Gheit. “That’s not disparaging. In this business I’d rather be lucky than smart. “Give them plenty of credit: They didn’t freak out,” he continues. “They didn’t succumb to pressures—‘I will sell out, thank God I’m breaking even, I’m going to get the hell out of this business.’ True refining companies—Valero, Tesoro, Frontier, Sunoco—these are the guys that really had the perseverance, the patience, and felt there would be a light at the end of the tunnel, and they were right. They were rewarded very handsomely.”
Bruce Smith Bio Title: Chairman, president and chief executive officer of Tesoro Corp. Work: Joined Tesoro as CFO in 1992. In 1995 he was named president and CEO and elected to the company’s board of directors. He was named Tesoro’s chairman in 1996. Previously, Smith was vice president and treasurer of Valero Energy Corp. Family: Married, five sons ages 19 to 33. Grew up in Coffeyville, Kan., population 16,000. Hobbies: Golf, skiing, tennis, reading and traveling with his wife and family. Golf handicap: 20. Favorite family vacation: Skiing in Aspen, Colo.
The Spoils California is a quirky state and, like many unique entities, its differences add value. Three factors make it a profitable place to refine oil, all of which involve limited supply and, hence, larger margins: Refiners must produce gasoline that conforms to standards set by the California Air Resources Board (CARB), and neither refining nor importing facilities are easily expanded. Tesoro, like Valero, refines heavy, sour crude, which refiners can buy much cheaper than sweet, more easily refined crude but get the same price and margin once it’s turned into usable gasoline. This crude has been cheaper in California than on the Gulf Coast. The two sets of circumstances converge at the Golden Eagle and Wilmington refineries, where each refines heavy, sour crude. So why in 2006 would Shell sell Wilmington and 278 stations it supplied? Hackett’s opinion is that for 100,000 barrels per day (bpd), the refinery needed more upgrading investment than it was worth to Shell. Shell spokeswoman Alexandra Smith said the move aligned with its
strategy of “more upstream, profitable downstream” and that “at times we are approached by others that have an interest in our assets and who place a value on them that is beyond what we can realize ourselves, given our strategic investment options.”
Not a Retailer? In two strokes, Tesoro increased its refining capacity to 660,000 bpd and set the stage for expansion beyond the retail locations it bought from Shell and USA Petroleum. Before the deals, each of which closed in 2007, Tesoro’s most noticeable presence was as a supplier to wholesalers. There were 13 Tesoro-branded sites in California and six locations under the Mirastar brand (Tesoro’s partnership with Wal-Mart). Now there are approximately 400 more locations that will be run by Tesoro but will keep Shell and USA signage. Both refineries can supply USA sites, while all Shell sites—under contract for years to come—will get Wilmington product. Westfall says retailing is important to Tesoro as an end to a means, and that
“[USA] has a pretty good image, so why spend money? The image is fine and it’s well-known, and you can make your margin whether it’s got your name or somebody else’s.” RON VANDEPOL VanDePol Enterprises
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retail expansion will happen only in range of the company’s refineries. With that in mind, Tesoro will increase its CARB-standard gas production at Wilmington as much as 20,000 bpd in the next year, he says. He says Tesoro has the right to expand the Shell brand in relevant marketing areas and would opt for rebranding open dealers rather than owning sites. “We don’t believe there’s any one formula that’s right,” says Westfall. “Depending on the concentrations of the market, if we can get some economies of scale we don’t mind operating them ourselves. But as you get that dispersal in the market, it’s almost better to have a jobber operate them.” Two men from downstream California welcome Tesoro’s larger presence in their state: Jay McKeeman,vice president of government relations for the California Independent Oil Marketers Association (CIOMA); and Ron VanDePol, president of VanDePol Enterprises,a distributor and marketer out of Stockton. Both say Tesoro is considered a friend of the unbranded market. CIOMA wrote a letter of support for Tesoro’s acquisitions to the California attorney general, while VanDePol’s company has been a Tesoro customer for years. McKeeman says Tesoro won his organization’s support by telling the same story to CIOMA as it had to the Federal Trade Commission—most importantly that there would be plenty of fuel available for the unbranded market after Tesoro supplied the Shell and USA stations. Would independent competitors be squeezed? The guarantee of increased production tipped the scales. “That’s a huge element,” says McKeeman.“Again, we’re not typically fond of
As for the USA stores,VanDePol says if Tesoro can instill in the new stores the customer-service vibe that he gets in his dealings with the company, they can shine. “As long as they allow the operator to upgrade them a little bit, they’ll be fine,” he says.“They’re very friendly and very upfront. If they can pass that on to the USA organization, I think it’s a win for the public.”
Debt-Free
2GO WEST: At the end of 2006, Tesoro boasted 117 company-operated and Tesoro-branded 2Go stores throughout the Western United States. Seventy-seven company-operated stores flew the Mirastar flag on the outlots of Wal-Mart locations.
when refiners take on retail, because obviously they have a better ability to do direct pricing to their service stations and that typically competes with us, especially when unbranded prices are high, branded prices are lower.That’s certainly a thorn in our side.” According to McKeeman, Tesoro won CIOMA’s endorsement by showing it could make the retail acquisitions and still increase the amount of unbranded fuel distributed in the state. Says Westfall of having to satisfy Californians, from the street to the statehouse, “The higher up the chain you go, the more they’re interested just in overall supply growth and less of what 90
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channel it goes into. We were able to demonstrate that [for] virtually every refinery we’ve bought, we have increased the capacity of it.” VanDePol says Tesoro is not “egodriven” as much as it is concerned about throughput, as evidenced by the plan to keep USA and Shell signs on its new sites. It’s a good economic move as well, he says. “[USA] has a pretty good image, so why spend money?” says VanDePol. “Nowadays it costs about $30,000 to $45,000 to reimage a station. The image is fine and it’s well-known, and you can make your margin whether it’s got your name or somebody else’s.”
Here’s how Tesoro has emerged from the debt crisis: Its debt-to-capitalization ratio was 29% at the end of 2006, it had twice as much cash on hand as at the end of 2005, and its 2006 net income was 58% higher than the previous year. Tesoro used cash to pay for one-third of the $1.76-billion deal with Shell. Its record first-quarter 2007 net income was $116 million, or $1.67 per share, more than $1 over the same period in 2006. Its board approved a 2for-1 stock split May 1 and doubled the quarterly cash dividend. As Westfall says, the combination of unanticipated supply and/or demand issues and overextension is unlikely to happen again thanks to its financial status. The former will take place—volatility is the norm—but Tesoro is well-positioned to weather it. “Those are temporary dips, not fundamental changes,” he says.“Fundamental changes would be longer-term—for instance, alternate fuels, ethanol—but that’s nothing that’s going to happen overnight. “We built the company through acquisitions, so we’re always looking to grow, but we’ve gotten to the size where we don’t feel compelled to grow.” ■
