Downbeat on Sunoco Near-Term

Mar. 8.10 | About: Sunoco LP (SUN)

Last month, Sunoco Inc. (NYSE:SUN), the Pennsylvania-based oil refiner and marketer, announced its financial results for the fourth quarter and fiscal year ended Dec. 31, 2009 (see conference call transcript here).

Disappointing Results

For the fourth quarter, Sunoco reported loss per share (excluding special items) of 27 cents, a penny wider than our estimates. The challenging market environment continued to adversely impact the company’s volumes and margins in its petroleum and the chemical businesses.

In the year-ago period, Sunoco earned $2.68 per share. However, revenue of $9.0 billion was up 3.8% from the fourth quarter 2008 level.

Full year 2009 results were no less disappointing, with Sunoco reporting a net loss of 33 cents per share, compared to income of $7.48 per share in 2008. Annual sales declined to $31.3 billion from $51.1 billion in the year-ago.

For more information and more detailed analysis of the fourth quarter results, please refer to this link.

Negative Surprise Trend

It was the company’s third negative earnings surprise in the past four quarters. Sunoco has performed poorly during this period with its average earnings surprise being a staggering -748.6%.

Reasons for the Underperformance

The overall environment for refining margins and volumes remains challenging. Weak demand for refined products in the global downturn and increased capacity has squeezed margins throughout the industry.

Being one of the largest independent refiners, Sunoco, along with Valero (NYSE:VLO) and Tesoro (NYSE:TSO), remains particularly exposed to this unfavorable macro backdrop. The fourth quarter benchmark refining margins worsened from the previous quarter and the rising crude oil prices also negatively impacted the company’s margins by increasing the cost of oil it buys to make gas, jet fuel and other refined products.

Partly offsetting the challenging macro environment are Sunoco’s growing non-refining businesses, which diversify its portfolio and provide the company with more stable revenue streams. In particular, Sunoco's coking operations, which are linked to the health of the steel industry, were profitable on both the quarter and the year.

Strategic Initiatives

Sunoco has announced certain strategic actions to improve the company’s performance and competitiveness in a cost-effective manner, as it struggles to cope with the bearish refining margin environment. These include the closure of the previously-idled Eagle Point (New Jersey) refinery, a definitive agreement to sell the polypropylene business and cutting its dividend. Early last year, the company sold its Tulsa refinery and Retail Home Heating Oil business. We believe these moves will improve Sunoco’s near-term liquidity by saving more than $300 annually.

The company also strengthened its liquidity position through the sale of 2.2 million of its Limited Partnership units in Sunoco Logistics Partners L.P. (NYSE:SXL) for net cash proceeds of about $145 million.

Outlook Bearish

Sunoco continues to expect a challenging market for petroleum and chemical products due to ongoing economic weakness and excess global supply. We agree with management’s view and see refining margins over the coming 6 – 12 months to be quite taxing. At the same time, we believe that refining margins bottomed in the final quarter of 2009 and don’t see them going much below that level.

Additionally, Sunoco is not just a refiner and supplier of gasoline. We are bullish on the company’s coke business, which is poised to benefit from the strong outlook for global steel construction use. The recently-completed Granite City plant and the upcoming Middletown facility (both having long-term agreements with steel companies) are likely to each contribute $35 – $40 million annually to the company’s income, thereby acting as the growth catalyst in the next few years.

The company released 2010 capital expenditure guidance of $840 million, which includes $280 million for growth programs primarily related to the Middletown coke facility.

As mentioned above, management has taken certain tough decisions to preserve liquidity and the strength of the balance sheet. Liquidity enhancements will ensure the company’s survival during the downturn, but until we see a turnaround in refining margins, we expect no upside in the stock. As has been the case during the last few quarters, non-refining profits are likely to be dwarfed by losses in the main (refining) business.

Estimates Falling

The negative trend is clearly visible in its near-term estimates revisions. We note that 6 of the 14 analysts covering Sunoco have reduced their earnings estimates for the first quarter of fiscal 2010 over the past 30 days. Only 1 analyst moved in the opposite direction during this time-period. Overall, earnings estimates for the first quarter are down by 10 cents, with the current Zacks Consensus Estimate standing at 2 cents (with a downside potential of 4 cents or 200.0%).

Earnings should pick up as the year progresses. For the second quarter of 2010, the Zacks Consensus Estimate is 56 cents (with a downside potential of 9 cents or 16.1%). But even in this case, the overall trend in estimate revisions is unfavorable. Over the past 30 days, estimates have been down by 22 cents with 8 of the 13 analysts covering the stock cutting back on their estimates. There were no positive revisions during this period.

Considering the negative earnings revisions trend and given that the overall environment for refining margins is likely to remain poor, our short-term recommendation on the stock is Sell (Zacks Rank #4), meaning that Sunoco is expected to underperform relative to the overall market during the next 1-3 months.

Therefore, the stock should most likely be sold or avoided over this time period. The sharply lower refinery utilization (at just 81.9% of capacity) provides enough evidence that refineries are cutting back on production because the economy is still struggling on the demand side.