We have downgraded Western Refining Inc. ( WNR - Analyst Report ) shares to Neutral from Outperform following the independent oil refiner’s weaker-than-expected operating results.

Incorporated in 2005, El Paso, Texas-headquartered Western Refining’s operations are concentrated in the Southwestern and Mid-Atlantic regions of the U.S. The company operates in three segments: Refining (accounted for 93% of the company’s total 2011 operating income), Wholesale (6%) and Retail (1%).

On November 1, Western Refining came out with weak third quarter profits due to higher operating expenses and lower refining margins. The company reported earnings per share (excluding special items) of $0.99, much lower than prior-year quarter earnings of $1.37. Earnings also fell well short of the Zacks Consensus Estimate of $1.46 per share.

Additionally, in terms of geographic diversification, Western Refining’s lack of exposure to the other refining regions in the country weakens its competitive positioning. In our view, the company’s Southwest-centric operating footprint acts as a major liability.

Western Refining is also faced with volatile industry fundamentals, which may further limit its ability to generate positive earnings surprises.

However, all is not bleak with the company, which has achieved considerable success in reducing debt and in its initiatives to improve reliability/reduce operating costs.

Most importantly, Western Refining’s easy access to the lower-priced West Texas Intermediate (WTI) crude gives a cost advantage that is reflected in the company’s high gross margins vis-à-vis its peers like Valero Energy Corp. ( VLO - Analyst Report ) and Tesoro Corp. ( TSO - Analyst Report ) .

Overall, we think the current valuation is fair and adequately reflects the company’s future growth prospects. As a result, our long-term total return expectation for Western refining remains rather muted.

We do not see any significant price upside for the shares in the next few quarters and expect the partnership to grow at a somewhat more conservative and sustainable pace. Our new long-term Neutral recommendation is supported by a Zacks #3 Rank (short-term Hold rating).