Monday, July 13, 2009

Sunoco: A Chart Watcher's Nightmare...

Sunoco Inc. is somewhat of an oddity in the big-oil names: it's a downstream player. During 2008, about 55% of its income (before general corporate expenses and other items) came from refining and marketing. About 21% came from retail sales of gasoline. About 11% came from Sunoco's coke and coal division, 9% came from logistics (crude transportation), and the rest came from its chemicals division. There are no revenues to speak of from purely upstream operations.

There's another oddity, even with respect to the Low P/E bin: currently, Sunoco is selling below book value. As of March 31st, it had no intangible assets or goodwill on its books; hence, its book value is equal to its total equity. It has no preferred shares on its books, nor any preferreds authorized, but minority interests are entitled to some of the common equity. The total equity available to Sunoco shareholders is $2,834 million, or $24.25/share using Mar. 31st's total shares outstanding. At today's closing price of $22.35, Sunoco is selling at slightly less than that book value.

The reason why isn't that hard to guess if the recent fate of the oil refiners is known. As noted above, more than half of Sunoco's earnings come from refining and (wholesale) marketing. The crack spread has plummeted this quarter, leaving the source of most of Sunoco's earnings vulnerable to a real squeeze. Sunoco has already faced such a squeeze in 1Q '09. It's also faced said squeeze in 1Q '08, which saw a loss of 50 cents/share. 1Q '09's EPS was 54 cents.

So, ostensibly, Sunoco's most recent quarter looks fairly good by comparison. The trouble with extending it, though, is that doing so ignores the crack-spread collapse. It's true that Sunoco will benefit from the current drop in crude, but it will suffer from the current drop in gasoline and other distillates. Unless the supply-demand picture for distillates changes markedly, there won't be the third- and fourth-quarter earnings bonanza that 2008 saw.

Evidently, the slow but sure slide in the price of Sunoco's stock results from discounting its somber future for the rest of this year. Earnings-wise, Sunoco is lilkely to disappoint; asset-wise, though, it's beginning to move into value territory.

Unfortunately, its current ratio shows a dependence upon standby lines of credit: as of March 31st, its current ratio is 0.804. The quick ratio is 0.571. Although I don't believe that the company will be thrown into turmoil as a result of its credit facilities being yanked, these ratios show something about management's view of financial prudence.

The overall picture I get of Sunoco is of a turnaround in the making. Although the price-to-book may impress some, its margin of safety is too inadequate for someone buying on hard Grahamite principles. Going into Sunoco now, on the basis that its price-to-book ratio will return to normal once the skies clear for it, would be more of a speculation than a true value investment. I can point to its 10-year return on equity of 28.6%, or its 10-year continuting operations EPS growth (calculated through logarithmic regression) of 28.5%, but those figures matter little when more immediate storm clouds are visible.

As far as dividends are concerned: Sunoco is no Dividend Aristocrat, but it has never passed or cut its dividend in the last ten years - not even in 2002, when the company lost 31 cents per share for the entire year. It current payout rate is 17.0%, with high earnings being the reason for the low ratio. The same calculation for Sunoco's 10-year average EPS gives a ratio of 30%. Given past behavior, it's unlikely that Sunoco will chop or pass on its dividend this year even if 2009 turns out to be another 2002. Incidentally: with respect to Sunoco's 10-yr EPS average, its current P/E is 5.6.

However, Sunoco is still only a turnaround in the making. The bad news hasn't come out yet, nor has its 12-month trailing EPS dropped below its 10-year average. On the basis of inadequate margin of safety, a Grahamite would pass. So would an EPS-driven turnaround investor. The only person who would be interested in this stock at these levels would be someone who believes that the market has already discounted 2009's earnings drops, or that the retail division will enjoy a leap in earnings enough to compensate for the lowered crack spread, or that the crack-spread collapse will reverse in the near future. Such a person would have to count on a steady dividend, so as to be paid for waiting. If Sunoco decides that cash conservation is more important than a reputation as a steady dividend payer, said person would be out of luck.

There's no compelling value in Sunoco to be pointed to, so I would have to make a definite recommendation on the stock to depart from commentary mode. I'm not licensed to do so in the jurisdiction where I live. (Ontario, Canada.) So, with respect to a stock that doesn't have any commentary-level feature to point to, I have to stay detached and leave it to the reader.

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