Sunoco's Sweeter Spot

Why its shares are trading at a premium over those of its peers in oil refining

Selling gasoline is generally a lousy business -- especially at a time when it's hard to pass on the cost of higher prices to Joe and Jane Motorist. In recent years many big players have been reducing their exposure to the gasoline business.

Not Sunoco Inc. (SUN ). The Philadelphia refiner is one of the biggest operators of filling stations in the U.S. Last year it added some 275 locations, bringing its total to around 4,800 -- mostly in the Northeast and Midwest. Sunoco pulls in almost 50% of its revenue from its retail division, which includes gas stations and related APlus convenience stores. And yet Sunoco shares are trading at a premium to its peers, including refiners Marathon Oil (MRO ) and Valero Energy (VLO ).

Of course, it is the buoyant refining business that has helped Sunoco vault to the No. 18 spot on the BusinessWeek 50 list of top corporate performers. As the fourth quarter began, Sunoco had netted a record $687 million on $24.5 billion in sales. Right now, the retail operation barely contributes to the bottom line -- just $5 million in 2005 so far. But the good news in a boom and bust business is that when refining profits slump, gasoline profits rise. "The retail sector adds stability to their earnings," says Tina Vital, a Standard & Poor's (MHP ) equity analyst.


The gas station strategy makes a lot of sense for Sunoco, since it is more susceptible to a margin crunch than many rivals. The company uses mostly light sweet crude, which is generally cheaper to refine than other oils. But light sweet crude is also pricier, which cuts into margins. Heavy sour crude, used by Valero, for example, can be from $10 to $15 per barrel cheaper. Sunoco's answer is to start processing more high-acidic oil, which it says is plentiful in Nigeria and other parts of Africa, and Syncrude, the synthetic substance made from Canada's tar sands. Both are cheaper and would allow Sunoco to boost its margins.

What has impressed analysts most, however, is the shrewd way Sunoco has been bolstering its retail presence. "It's a tough business," admits Robert W. Owens, who runs Sunoco's retail and marketing business. "You need a lot of discipline in how you manage it." So while Sunoco is opening new locations, it is steadily reducing the number of stations it owns directly. Increasingly, its stores are run by lessees or licensed dealers -- who take over many of the costs and headaches. That reduces Sunoco's take on sales of Twinkies and cigarettes, but it also means pouring less capital into the business. "I'm not a huge fan" of gas retailing in this industry, says Nicole Decker, a Bear Stearns Cos. (BSC ) analyst. "But I think Sunoco is managing it in an intelligent way."

The business only figures to get tougher, as Wal-Mart Stores Inc. (WMT )and Costco Wholesale Corp. (COST ) have started putting pumps in front of stores in selected parts of the country. Costco and Wal-Mart price their gas at or below cost to pull traffic into the stores, says Keith Reid, a senior editor at trade publication National Petroleum News. But invading Sunoco's turf in the Northeast has been a challenge: It's tougher to retrofit parking lots for gas pumps in a region that's land-scarce, has older infrastructure, and a tougher regulatory environment. Still, two major price warriors are entering the gasoline business. That's good news for drivers, but makes the retail game more complex for Sunoco, especially once the refining profit party winds down.

By Brian Hindo

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