TOP CONTRIBUTORS

Michael McGillen

Diwaker

Avinash Gandhi

SUN AT A GLANCE

P/E ► 3.97 LOW EV/EBITDA ► 2.78 LOW ROA ► 6.6% AVG ROE ► 28.4% HIGH Debt to Equity ► 3.29 HIGH Current Ratio ► 0.840 LOW Interest Coverage Ratio ► 11.4 AVG

 

 

 

 

 

 

Sunoco Inc. (NYSE:SUN): As the second largest independent refiner in the United States in terms of capacity, Sunoco is capable of producing 910,000 barrels of refined crude product per day.^[1] Its five refineries are located all over the U.S. and produce gasoline, jet fuel, heating oil, and diesel fuel. Through its logistics department, Sunoco transports its crude oil and refined products through a network of company-owned pipelines spanning approximately 6,000 miles.^[2] While Sunoco distributes refined products all over the U.S., its sells its refined products primarily on the east coast.^[3] Although the company's refining business is the largest segment in terms of revenue, 47% of Sunoco's 2008 earnings came from its non-refining business, which includes 4,700 retail stations, chemical manufacturing plants, and a series of coke manufacturing plants.^[4]

Because Sunoco's revenues come from a variety of sources, the company's earnings were not as exposed to volatile oil prices in 2008.^[5] Overall, the company earned $874 million in 2008, an increase of 7.5% from 2007.^[6] In particular, the company reported record earnings for its retail segment and its logistic department, which operates the company's pipelines.^[7] While oil prices remained low in the second half of 2008, Sunoco used its 2008 capital expenditures budget to increase their refineries' ability to process cheaper forms of crude oil.^[8] The ability to refine heavy, sour crude oil has the potential of reducing the cost of producing refined petroleum products. However, the price differential between sour crude and more expensive sweet crude has less of an impact on a company's earnings when oil prices are low. ^[9]

Company Overview

In the first quarter of 2009, Sunoco earned $23 million from its refining and supply segment. For the same quarter in 2008, the company lost $123 million in its refining and supply segment.^[10] While throughput production declined 14% between the first quarter of 2008 and the first quarter of 2009, refining margins increased 95% and were responsible for the improved earnings in the first quarter of 2009.^[11] Because crude oil prices were lower during this period in 2009, the overall expenses for producing petroleum products declined. Overall, Sunoco's net income for the first quarter of 2009 was $12 million versus a net loss of $59 million in the first quarter of 2008.^[12]The increase in net income was a result of improved earnings in the refining segment and the company's logistics segment.^[13]

During the last few years, Sunoco has acquired a number of other companies to grow its current operations, such as the acquisition of Aristech Chemical Corporation and Eagle Point Refinery in 2001 and 2004, respectively, which allowed Sunoco to double the size of its chemical business and increase its refining capacity by 20 percent. The company is constantly upgrading its refining equipment, making its daily production capacity variable throughout the year.

Comparable refining capacity (volume in terms of barrels per day – BPD), expansion of distribution network, and presence across different geographies and business segments are the main drivers of revenue in the oil and energy sector.

The table provided below tracks the historical performance of Sunoco.

Source: Company Data

Although Sunoco is not in the oil exploration and production business, it is present in all stages of the supply chain from refining crude oil to selling petroleum products through its own retail gas stations. In addition to this, the company uses by-products of the refining process to produce chemicals and coke. The chemicals and coke business provides Sunoco with a stable flow of income/revenue as the demand for these products does not reduce even if the demand for other petroleum products declines.

Sunoco has a large distribution network in the form of pipelines for transporting refined products, such as gasoline, lubricants, and crude oil. This network of pipelines reduces the cost of transporting these products for the company. Further, the company also has approximately 4,800 retail gas stations and distributor outlets spread across the Northeast, the Midwest and the South Central. These widespread retail outlets enable effective distribution of gasoline and related products. The presence of such a large number of retail gas stations also enables the company to establish its presence among its end consumers.

Sunoco owns real estate assets (in the form of retail gas stations) and as part of its recent strategy, Sunoco is restructuring its existing network of retail gas stations. Sunoco is trying to improve the portfolio of real estate owned by it (in the form of retail gas stations) by selling retail gas stations, which generate low revenue and establishing gas stations in locations, where sales will be higher (called as the Retail Portfolio Management - RPM, strategy by Sunoco).

The company faces the risk posed by natural disasters. Hurricanes such as Katrina and Rita can destroy its infrastructure. Historically, 3Q margins are lower than 2Q margins because hurricane season falls in the third quarter, cutting margins down yearly. Hence, the company is required to make provisions to protect its infrastructure from such calamities.

Environmental hazards are another area of concern. Environmental hazards include the use of the chemical methyl tert-butyl ether (MTBE), which contaminates groundwater and causes environmental pollution; the company has faced some litigations for the use of this chemical.

Business Segments and Products

Sunoco’s operations can be divided into five segments – refining, retail gas stations, chemical, logistics and coke. Refining contributes the largest share of revenue to the company (49 percent of the total revenue during 2005), followed by retail gas stations (35 percent), logistics (8 percent), chemicals (7 percent) and coke (1 percent). The product portfolio of Sunoco is marketed under two brands – Ultra 94 and Sunoco.

The refining segment comprises production of refined products (gasoline, diesel, lubricants, etc). No new refineries have been set up in the U.S. since 1976. This is primarily due to the high cost and strict environmental restrictions on setting up refineries. Even the cost of expanding the capacity of existing refineries is high. Refineries have increased production primarily by making technological upgrades to their existing refineries and by acquiring other older refineries, which has limited the supply and led to an increase in price.

Retail gas stations are primarily involved in the sale of products, such as gasoline and middle distillates (heating oil and diesel) as well as operating convenience stores in the gas stations. The chemical segment comprises operations, such as production, distribution and marketing of petrochemicals, including phenol and polypropylene. The logistic segment involves the transportation of crude oil from oil wells to refineries and of gasoline and other products from refineries to retail gas stations through pipelines. The coke segment produces petroleum coke. In March 2009, Sunoco announced that it would sell 164 stores in the U.S. in order to raise cash for investments in their refining equipment.^[14]

Customer Demand

As with other companies operating in this sector, Sunoco is vulnerable to a decline in the demand for energy and other related products as a result of an economic downturn in the country; the demand for energy is closely linked to overall economic growth of a country.

The demand for heating oil such as diesel fuel is increasing among the residential customers. However, the demand for heating oil changes with the change in season. For example, demand is higher during winters as compared to the demand during summers. On the other hand, the supply of heating oil is affected by increase or decrease in the inventory levels of the company, political uncertainties, and limited production capacity. The price of heating oil fluctuates as a result of this dynamic demand and supply situation, which poses a challenge for the company.

Sunoco’s coke segment sells most of its output to a single customer on a long-term contract, which exposes the company to the risk of fall in earnings if that customer does not honor that contract.

Trends and Forces

Oil Downturn in 2Q 2009 Benefits Sunoco Logistics , but Detriments Principal Operations

Lower refining profit margins for Sunoco's refined petro-products and chemicals led to a quarterly loss of $55 million in the second quarter of 2009.^[15] Refining and supply operations had a loss from continuing operations totaling $77 million of which $6 million in losses came from the close of its Tulsa refinery.^[16] While several of its operations were profitable in the second quarter, Sunoco focused on cutting the costs of its refining operations.^[17] Through the sale of its Tulsa refinery and the purchase of a 100 million gallon-per-year ethanol facility in New York, Sunoco has the potential of relying less of the price and demand for refined petroleum products.^[18]

Although its largest segments by revenue declined in the second quarter of 2009, revenue from Sunoco's logistics business increased18%.^[19] Overall, revenue declined 61% from a drop in the prices of oil and the oil products it transports.^[20] Sunoco Logistics increased from operations in the contango market. In a contango market, a futures contract for a commodity is more expensive than the present cost of the commodity. If the contango is large enough, an investor can buy a commodity, sell a futures contract on it and make money by just holding the commodity until it has to be delivered.^[21] As a result, Sunoco, which owns 40% of Sunoco Logistics, has the potential of hedging losses from its oil operations.^[22]

Downturns for Gasoline, Chemical Consumption force Sunoco to Halt Expansions, Close Facilities

At the end of 2008, America’s petroleum demand fell to its lowest levels since 2003 amid less consumption of refined gasoline.^[23] In the second half of 2008, American refineries cut gasoline production 2% in an effort to produce more profitable products like diesel, which increased by 10%.^[24] Like many refiners, Sunoco has paused expansion and upgrade projects. In particular, Sunoco has halted equipment improvements on its Tulsa refinery.^[25] According to Sunoco’s management, the company will pursue a potential sale of the facility if refining output remains low in 2009.^[26] But downturns in the chemical industry, which accounted for 7% of Sunoco’s 2007 revenue, have forced the refiner to shut down its Texas polypropylene plant.^[27]

In early 2009, Sunoco entered contract negotiations with 1,300 of its Philadelphia refinery workers, all members of the United Steelworkers Union.^[28] Up to 1,000 workers threatened to go on strike when Sunoco announced that it would cut 200 jobs at the refinery.^[29] Through negotiations, Sunoco was able to prevent a refinery-wide strike and is expected to have a Union contract ready to be signed during the week of March 8, 2009.^[30] A strike at the Philadelphia refinery has the potential to shut down the refinery completely and reduce refining production by 36%.

In March 2009, Sunoco cut 750 jobs, about 20% of its workforce, in an effort to reduce operating costs.^[31] The oil refiner will cut its work force, equipment investments, and other refinery costs in order to reduce its 2009 operating expenses by $300 million.^[32]

For independent refiners, future profits depend heavily on rising demand for gasoline and diesel. Low levels of gasoline consumption have the potential of significantly impacting the balance sheets of U.S. refiners by forcing many refiners to shut down idle refineries and write down their value.^[33] However, demand is not likely to reach 2007 peaks according to the Wall Street Journal. Factors the have the potential of curtailing gasoline demand include the long-term transition to more fuel-efficient vehicles, high unemployment rates, and growing concerns over environmental protection.^[34] According to analysts at the brokerage firm Caris, refining margins are capable of remaining low through the second half of 2009.^[35]

In the third quarter of 2009, Sunoco shut down its New Jersey refinery in order to cut costs amid small profit margins.^[36] Including the New Jersey shutdown, Sunoco has reduced overall refinery utilization to 78% of capacity in 2009. Although refinery shutdowns eliminate potential losses from refining, they have the potential of burdening the operational refineries.^[37] With less refineries operating, Sunoco has had to increase utilization rates at its larger refineries in order to prevent a shortage of fuel at its retail gasoline stations. Cutting costs has been the focal point of Sunoco's operations 2009 due to rising crude prices and shrinking refining margins.^[38] In addition to refinery shutdowns, the company also has cut its dividends by half to converse its cash balances.^[39]

Sunoco moves in renewable energy market with ethanol plant purchase

In June 2008, Sunoco completed its purchase of a Northeast Biofuel plant for $8.5 million.^[40] Through its purchase, Sunoco has acquired an ethanol plant with annual production capacity of 100 million gallons.^[41] The plant has the largest production capacity in the northeastern United States, which is Sunoco primary market in terms of 2008 sales^[42]. The purchase of this plant is Sunoco's "first step" into the alternative fuels market. The company has the potential of increasing its production capacity, through acquisitions or plant improvements, because the plant purchased from Northeast Biofuel is capable of supplying one quarter of Sunoco's ethanol needs.^[43]

Sunoco Often has to Pay RecompenseI for Environmental Damages

Oil refining can have a terrible effect on the environment, as chemicals used to turn oil into various types of fuel are released into the air and groundwater. When the environmental damages caused by Sunoco's operations occur to the extent that they break environmental protection laws, the company is often sued by NGOs or government agencies like the Environmental Protection Agency. These lawsuits are usually settled out of court; on May 7th, 2008, for example, Sunoco, Shell, ConocoPhillips, Chevron, Marathon Oil, BP, and Valero agreed to pay $423 million in damages for contaminating groundwater with methyl tertiary butyl ether, an oxygenate used to increase octane levels in gasoline that has been replaced in recent years with ethanol. Exxon Mobil, along with five other companies named in the lawsuit, are not settling and will continue to contest.

The "Green Revolution" is a Threat to Sunoco's Ability to Sell its Products

Whether it’s because of the desire for energy independence, the rising price of oil, or fears of climate change, people are becoming more and more disillusioned with petroleum. Environmentalists have been calling for a shift to renewable energy for years, and though the river of change is running slow, it is running deep. Internationally, the Kyoto Protocol has started a shift toward cleaner sources of energy, and though the U.S. isn't partaking Kyoto's changes, the recently passed Energy Independence and Security Act of 2007 is the first step towards a grander series of changes. By forcing automakers to achieve 35 mpg by 2020 and setting a Renewable Fuel Standard of 36 billion gallons of biofuels in 2022^[44], the Act could greatly reduce the growth of the petroleum refining industry - and environmentalists, who have deemed climate change to be "Our Generation’s Defining Moral Challenge", will continue to push for greater change.

Gasoline makes up more of Sunoco's production than any other petroleum product - 48.5% of the company's 906,000 barrels produced every day in 2007 were filled with the fuel^[45]. Reduction in demand for gasoline caused by improving fuel economies and shifts towards cars with different power sources like ethanol and other biofuels would lower gasoline prices, crunch margins, and cut Sunoco's revenues.

Competitive Landscape

Companies in the oil and energy sector operate and compete with each other in different areas, such as chemicals, refining, oil exploration, etc. Sunoco faces direct competition from companies, such as Valero, Western Refining, Hess, Motiva Enterprises, Shell, Exxon Mobil, Chevron, and ConocoPhillips, etc.

To gain an advantage over its competitors in the industry, Sunoco has resorted to various measures. Some of these include entering new business segments (such as refining, retailing, chemicals and coke) and increasing the number of retail gas stations

At present, Sunoco’s refineries in the US are primarily involved in refining sweet crude. Although sweet crude is cheaper to process/refine, it is expensive as compared to sour crude, which is used by some of its competitors such as Valero. However, as a majority of the players do not have the capability to refine sour crude, it is not a major threat or challenge for Sunoco.

Further, unlike the larger players operating in this industry, such as Exxon, which finds new oil reserves (exploration), produces crude oil, refines it and then sells it through its retail gas stations, Sunoco is not involved in exploring and producing crude oil.

The table provided below compares the operational metrics for Sunoco vis-à-vis its competitors in 2008.

(1) Latest data is for 2007

Notes

1. ↑ Sunoco 2008 Annual Report
2. ↑ Sunoco 2008 Annual Report
3. ↑ Sunoco 2008 Annual Report
4. ↑ Sunoco 2008 Annual Report
5. ↑ Sunoco 2008 Annual Report
6. ↑ Sunoco 2008 Annual Report
7. ↑ Sunoco 2008 Annual Report
8. ↑ Sunoco 2008 Annual Report
9. ↑ Sunoco 2008 Annual Report
10. ↑ SUN Financial Report for first quarter 2009, page 20
11. ↑ SUN Financial Report for first quarter 2009, page 20
12. ↑ SUN Financial Report for first quarter 2009, page 19
13. ↑ SUN Financial Report for first quarter 2009, page 19
14. ↑ Philly.com: Sunoco puts 164 stores, lots up for sale, March 2009
15. ↑ WSJ: Sunoco Reports Second Quarter 2009 Results, August 2009
16. ↑ WSJ: Sunoco Reports Second Quarter 2009 Results, August 2009
17. ↑ WSJ: Sunoco Reports Second Quarter 2009 Results, August 2009
18. ↑ WSJ: Sunoco Reports Second Quarter 2009 Results, August 2009
19. ↑ bizjournals.com: Sunoco Logistics earnings up 18% in 2Q, July 2009
20. ↑ bizjournals.com: Sunoco Logistics earnings up 18% in 2Q, July 2009
21. ↑ bizjournals.com: Sunoco Logistics earnings up 18% in 2Q, July 2009
22. ↑ bizjournals.com: Sunoco Logistics earnings up 18% in 2Q, July 2009
23. ↑ Yahoo! Finance: US petroleum demand in 2008 lowest in 5 years, January 2009
24. ↑ Yahoo! Finance: US petroleum demand in 2008 lowest in 5 years, January 2009
25. ↑ Sunoco Reports Third Quarter 2008 Results , November 2009
26. ↑ Sunoco Reports Third Quarter 2008 Results , November 2009
27. ↑ WSJ: Sunoco to Close Polypropylene Plant in Bayport, Texas, January 2009
28. ↑ [http://finance.yahoo.com/news/Sunoco-refinery-workers-stay-apf-14510290.html Yahoo! Finance: Sunoco refinery workers stay on the job, for now, March 2009]
29. ↑ [http://finance.yahoo.com/news/Sunoco-refinery-workers-stay-apf-14510290.html Yahoo! Finance: Sunoco refinery workers stay on the job, for now, March 2009]
30. ↑ [http://finance.yahoo.com/news/Sunoco-refinery-workers-stay-apf-14510290.html Yahoo! Finance: Sunoco refinery workers stay on the job, for now, March 2009]
31. ↑ New York Times: Sunoco Plans to Reduce Its Work Force by 20%, March 2009
32. ↑ New York Times: Sunoco Plans to Reduce Its Work Force by 20%, March 2009
33. ↑ WSJ: Oil Refiners May Never See the Good Times Come Back, September 2009
34. ↑ WSJ: Oil Refiners May Never See the Good Times Come Back, September 2009
35. ↑ WSJ: Oil Refiners May Never See the Good Times Come Back, September 2009
36. ↑ Market Watch: Sunoco slashes dividend, shuts New Jersey refinery, October 2009
37. ↑ Market Watch: Sunoco slashes dividend, shuts New Jersey refinery, October 2009
38. ↑ Market Watch: Sunoco slashes dividend, shuts New Jersey refinery, October 2009
39. ↑ Market Watch: Sunoco slashes dividend, shuts New Jersey refinery, October 2009
40. ↑ Domestic Fuel : Sunoco Completes Purchase of Ethanol Plant in NY, June 2009
41. ↑ Domestic Fuel : Sunoco Completes Purchase of Ethanol Plant in NY, June 2009
42. ↑ Domestic Fuel : Sunoco Completes Purchase of Ethanol Plant in NY, June 2009
43. ↑ Domestic Fuel : Sunoco Completes Purchase of Ethanol Plant in NY, June 2009
44. ↑ WhiteHouse.gov, Fact Sheet: Energy Independence and Security Act of 2007, http://www.whitehouse.gov/news/releases/2007/12/20071219-1.html
45. ↑ http://phx.corporate-ir.net/phoenix.zhtml?c=99437&p=irol-newsArticle&ID=1105320&highlight=
46. ↑ E 2007 Annual Report
47. ↑ SUN 2008 10-K, Item 7, Page 35
48. ↑ ^{48.0 48.1} CVX 10-K 2009, Item 1, Page 24
49. ↑ VLO 2008 10-K, Item 1, Page 3
50. ↑ ^{50.0 50.1} XOM 2008 10-K, Item 6, Page 43
51. ↑ RDS’A 2008 20-F, Results, Refining Data
52. ↑ Sinopec Investor Relations, Operational Statistics for 2008
53. ↑ WNR 2008 10-K, Item 7, Page 34
54. ↑ ^{54.0 54.1} COP 2008 10-K, Item 1, Page 16
55. ↑ ^{55.0 55.1} BP 2008 20-F, Item 1, Page 29
56. ↑ Lukoil Investor Relations – Fact Book 2008, Page 15
57. ↑ Conversion factor is 1 BPD = 50 tonnes per year
58. ↑ ^{58.0 58.1 58.2} TOT 2008 20-F, Item 4, Page 36
59. ↑ SUN 2008 10-K, Item 1, Page 1
60. ↑ ^{60.0 60.1} VLO 10-K 2008, Item 1, Page 1
61. ↑ RDS’A 2008 20-F, Results, Manufacturing
62. ↑ Sinopec Refining Overview
63. ↑ WNR 2008 10-K, Item 1, Page 19
64. ↑ Lukoil Investor Relations – Fact Book 2008, Page 16
65. ↑ SUN 2008 10-K, Item 1, Page7
66. ↑ CVX 10-K 2008, Item 1, Page 25
67. ↑ CVX 10-K 2008, Item 1, Page 26
68. ↑ XOM 2008 10-K, Item 2, Page 25
69. ↑ RDS’A 2008 20-F, Results, Marketing
70. ↑ Sinopec 2008 Annual Report, Business Review and Prospects, Page 20
71. ↑ WNR 2008 10-K, Item 1, Page 3
72. ↑ COP 2008 10-K, Item 1, Page 18
73. ↑ BP 2008 20-F, Item 1, Page 30
74. ↑ Lukoil Investor Relations – Fact Book 2008, Page 60