Investors loathe volatility. So do managers of corporations. Business 101 teaches executives the importance of generating smooth, dependable growth. Avoid the potholes, they say, by keeping sales and profits on a consistent path higher.
Three cheers then for the management team of Sunoco (NYSE:SUN). On Tuesday, the company announced the sale of its oil refinery business. The press release says it all: “Given the unacceptable financial performance of these assets it is clear that it is in the best interests of shareholders to exit this business.”
I’m surprised it took them this long to figure that out. The oil refining business is notorious for its low profit margins. There are moments such as this past year when those profits can be very enticing. There are other moments when the opposite is true. One costly outage at a refinery can turn profits to losses very quickly.
Wild swings in crude prices do not help matters. Relatively speaking, crude prices have been fairly stable over the past year. That’s why pure oil refining plays like Tesoro (NYSE:TSO) have approximately doubled in value during that time.
Recently, though, that stability has evaporated. Crude prices are moving just as crazily as the stock market during the past month. As a result, oil refinery stocks have pulled back. It would appear Sunoco is making this move at just the right time.
No wonder shares of Sunoco are up 9% on the news. Investors clearly are expecting a top-dollar price for the assets to be sold. More importantly, the company now being focused on pipelines and gas stations is deserving of a higher valuation given a more stable cash flow model.
The move by Sunoco follows Marathon Oil (NYSE:MRO) and ConocoPhillips (NYSE:COP), both of whom jettisoned refinery units recently. Marathon Oil announced plans to spin off its oil refinery business in mid-January. ConocoPhillips has been liquidating refining assets over the past year.
In addition to selling the refinery business, Sunoco has been buying back stock at what management clearly believes is a low price for the shares. The company has almost finished buying some $500 million in stock at an average price of $34.74 per share. At current prices, the company has made money in doing so.
From an operating perspective, the sale comes at a good time for Sunoco. In the last two quarters the company has missed analyst expectations by a wide margin. Although it made money in the last quarter ending June 30, Sunoco at 40 cents per share in profit fell seven cents short of Wall Street estimates.
For the full year, the company is expected to make only 40 cents per share. Next year, the company is expected to make $2.21 per share. At current prices, Sunoco trades for 17 times 2012 estimated earnings.
With management now able to focus on a business that is likely to be more stable and lucrative to shareholders, expect earnings estimates to increase in coming months. Already in the wake of the announced sale of the refinery business, Wall Street firm Benchmark Company upgraded the stock to “hold” from “sell.” Look for other firms to do the same.
Management is doing all of the right things, in my opinion. Next, investors can expect the company to announce a dividend — stable cash flow companies tend to pay handsome dividends. I think Sunoco has another 10% to 20% upside from here.
