Sunoco Upped to Neutral

Sunoco Upped to Neutral

Sunoco Upped to Neutral

We are upgrading Sunoco Inc. (SUN) shares to "Neutral" from "Underperform", reflecting the strong growth potential of the company's non-refining units, which diversify its portfolio and provide the company with more stable revenue streams.

Philadelphia, Pennsylvania-based Sunoco is a leading independent refiner and marketer of petroleum products. It is also a chemicals manufacturer and has interests in logistics and cokemaking facilities.

We are particularly postive on Sunoco's coke business that looks set to gain from the strong outlook for global steel construction use. The recently-completed Granite City plant and the upcoming Middletown facility (both having long-term deals with steel companies) are likely to each contribute $35 $40 million annually to the company's income, thereby acting as a growth catalyst in the next few years.

Additionally, Sunoco's logistics business, conducted through Sunoco Logistics Partners, L.P. (SXL), offers a fairly steady source of earnings and cash flows from its growing asset base.

We also welcome management's liquidity enhancement measures to ensure the company's survival during this bearish environment for refining margin. These actions include the closure of the previously-idled Eagle Point (New Jersey) refinery, the sale of the polypropylene business, and slashing its dividend. Early last year, Sunoco sold its Tulsa refinery and Retail Home Heating Oil business.

These moves will improve the company's near-term liquidity but until we see a turnaround in refining margins, we anticipate no upside in the stock, as non-refining profits are likely to be offset by losses in the main (refining) business.

Though refining margins have rebounded from the fourth quarter 2009 lows, they still remain way off the levels achieved a few years ago. We believe that the imbalance between supply and demand will remain in place for the next 6 - 12 months and negatively impact the bottom line. Being one of the biggest independent refining companies, Sunoco, along with Valero (VLO) and Tesoro (TSO), remains particularly exposed to this unfavorable macro backdrop.

Thus, we see Sunoco shares performing in line with the broader market and rate the company as Neutral.

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