What’s working capital?
Let’s analyze Tesoro Corporation’s (TSO) working capital (or WC) management over the years. WC is a key thing to watch in order to understand how a company manages its short-term assets and liabilities.
WC includes cash locked up in inventories (an asset), cash to be received from customers (accounts receivable, an asset), and cash to be paid to vendors (accounts payable, a liability).
Ideally, a company should have as little money as possible locked up in these things so the money can be used to grow the business or increase shareholder returns.
Accounts receivable (or AR) and inventories should be as low as possible, and accounts payable (or AP) should be at a comfortable level.
Tesoro’s working capital
Tesoro’s AR has increased far less than its AP over the last few years, which is a good sign and actually indicates superior WC management. However, Tesoro’s inventories have more than doubled.
Tesoro’s refining and marketing capacities have also expanded sharply as we saw earlier. So what matters more is the average amount of time cash remains locked in these items and the ratio of credit sales and vendor purchases to these items. The former is measured by the number of days outstanding, while the latter is measured by turnover ratios.
A company with receivables pending longer is, in effect, lending money to customers longer. On the other hand, a company with payables pending longer is borrowing money from vendors longer, interest free.
Tesoro’s AR turnover has been on an upward trend, while its days sales outstanding has been declining, indicating it has been improving its receivables management.
The company’s inventories seem to have risen more than the growth in its throughput, causing its inventory turnover (sales or cost of goods divided by inventories) to drop. Its days inventory outstanding has also been rising, indicating longer periods for inventories, including those under manufacture, to get converted to sales.
The mildly rising trend in Tesoro’s AP turnover and declining trend in days payables outstanding indicates that the company’s been paying off its vendors relatively sooner, which is some waning advantage.
Putting it all together, Tesoro seems to be using cash less efficiently, as reflected in its rising cash conversion cycle and inventory to cash days.
Tesoro Corporation (TSO) is the SPDR S&P Oil & Gas Exploration & Production ETF’s (XOP) top holding. This ETF, with top-performing refiners such as PBF Energy (PBF), Marathon Petroleum (MPC), and Western Refining (WNR) among its top ten holdings, is an ideal way to gain diversified exposure to the refining sector.