Sunoco Dropped to Underperform

We are downgrading Sunoco Inc. ( ) shares to Underperform from Neutral, because of its weak business model, geographically undiversified asset base and operational hindrances.

In mid-January, Sunoco completed the separation of its metallurgical coke manufacturing business, to SunCoke Energy Inc. ( SXC - Snapshot Report ) , a 100% publicly traded company. We believe that the transfer of SunCoke has made Sunoco a less diversified business model. As a result, Sunoco is exposed to greater competitive risks than it was prior to the spin-off.

In September last year, Sunoco also announced plans to put up its Philadelphia and Marcus Hook refineries for sale, in response to the challenging conditions in the refining market. The company is targeting to exit its refining business in or before July 2012.

Additionally, Sunoco exhibits a weak geographic diversification. In our view, the company’s lack of exposure to the other refining regions in the country weakens its competitive positioning. With about three quarters of its capacity located in the Northeast, the company’s results are heavily tied to refining margins in a single market.

We also remain apprehensive about Sunoco’s performance in the coming months as gains from successful restructuring initiatives by management over the last two years have been overshadowed by operational reliability issues and increased unscheduled downtime. We expect these issues to weigh on the company’s shares for some time to come.

Our pessimistic outlook on the stock also stems from the company’s poorly performing refining and supply segment, which incurred a heavy loss along with lower realized prices and throughputs in the fourth quarter of 2011. Sunoco also suffers from a greater financial risk that is showcased by a high debt-to-capitalization ratio of 65.6%.

These negative aspects indicate that investors have little reason to hold on to the stock at the current level.

Sunoco, which competes in the Oil Refining and Marketing industry with firms like Valero Energy Corp. ( VLO - Analyst Report ) and Tesoro Corp. ( TSO - Analyst Report ) , currently has a Zacks #4 Rank (Sell rating) for the short term.