Suncor Energy: A Good Play in Oil?
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Over the last year, the share price of Suncor Energy (NYSE: SU) has lagged the larger integrated oil companies from the U.S. as well as Britian's BP plc (NYSE: BP). Last fall BP earned a deepwater drilling permit in the Gulf of Mexico despite its central role in the 2010 spill. BP employs a centralized project management system that continues to work well and earn the company reasonably high returns on invested capital for each project. In contrast, Suncor brings some different factors to the market. While some of these factors can be considered as detriments, and others may make the Suncor model superior to the competition. Chief among them are Suncor's drilling geography, concentration, and potential technological and experience-related advantages. Investors should look at the pros and cons before deciding whether Suncor belongs in their stock portfolios.
What is Suncor's MO?
Suncor Energy is a Canadian energy company with a major focus on production from the Alberta oil sands. The company first exploited the oil sands in the 1960's and has been a leader in Canada's oil sands production ever since. In 2009, Suncor Energy merged with Petro-Canada to become Canada's largest energy company and the fifth largest in North America. Besides the oil sands, the company produces oil offshore eastern Canada and in the North Sea. Oil production was recently resumed in Libya. Suncor owns four refineries and distributes fuel and lubricants through 1,500 company owned retail locations. Suncor Energy is a major partner in the Syncrude oil sands production joint venture alongside another large Canadian integrated oil company, Imperial Oil (NYSEMKT: IMO). Imperial has seen revenue and profit growth of 10-30% over the last few years from its operations in Canada. While the company also has a chemical business that contributes to earnings, the key to Imperial's profitability is a high WTI (and other oils like Mars, Brent) crude price because of the relatively higher cost per barrel to extract from Canadian sands. As reflected in its 15% operating margin, Imperial's breakeven price is approximately $20-$40 dollars (depending on production and fixed costs) per barrel-equivalent below current WTI prices.
(Note: The largest partner in the Syncrude partnership is Canadian Oil Sands which is a pure play investment on Syncrude).
Oil Sands a Double-Edged Sword
The focus on producing oil from oil sands is both a strength and weakness for Suncor Energy. The positive aspect is that the oil sands provide many decades of reserves which the company can exploit. Suncor does not need to spend large amounts of money on exploration for new oil sources. The negative factor is that producing oil from oil sands is more expensive than from conventional oil wells. Cash operating costs for the company are about $35 per barrel. The cost advantage of the traditional oil production methods is slowly eroding which Suncor has been able to stay pretty close to the $35 per barrel goal over the last several years.
Suncor Energy has used its refining operations to generate better than typical profits from downstream operations. Oil sands oil production is typically priced on West Texas Intermediate – WTI – prices. The company's refined products are priced based on the Brent crude oil price. Over the last year or so, the market price of Brent crude has been significantly higher than the price for WTI. The company notes that two-thirds of the oil it refines would be WTI priced and one-third would be Brent priced if sourced outside the company's own production. The refinery output products are all priced based on the global values for refined products and those prices are primarily driven by the widely followed – outside the U.S. – Brent crude price.
The Suncor Energy share price has significantly under-performed the large global integrated oil companies over the last year. The Suncor share price is down 26% over the last 12 months. In comparison, the prices of Exxon-Mobil and Chevron are at break even for the period. BP shares are down about 5%. Suncor, with a P/E ratio of 11.7 trades at a significantly higher multiple than its larger competitors. Part of the cause of the poor share price performance can be attributed to the lower relative dividend rate paid by Suncor – even after Suncor increased the quarterly dividend by 18% with the first quarter earnings announcement. The company pays out less than 20% of net earnings, leaving the share price more vulnerable to market forces.
Although Suncor Energy has a long term goal to increase production by 8% per year, the company's 2011 guidance is a range of 530,000 to 580,000 barrels of oil per day. The 2011 production level of 562,000 barrels per day is right in the middle of the forecast ranges, providing an outlook of level production in 2012. The company is just over half-way through an authorized $1.5 billion share buyback, which should help the earnings per share as the share count continues to decrease. The Wall Street consensus earnings estimate for 2012 is $3.37 per share, down from $3.62 earned in 2011. The reported 2012 first quarter earnings of 93 cents per share exceeded the consensus estimate of 91 cents.
It's Crude, Stupid
The results for any energy production company are highly dependent on the price of crude oil and/or natural gas over the selected time period. Suncor Energy fell out of investor favor in 2011, but the share price is up about 11% through the first four months of 2012, while the major competitors discussed earlier remain at the break even point so far in 2012. Suncor Energy has one of the best prospects for long term growth of oil production. The oil sands are in energy-friendly Canada and the company can expect improved results and increased reserves as the technology to process oil sands improves. The big danger for Suncor Energy is a significant and prolonged drop in the market price of oil. Investors should consider this stock for the long term, but be ready to sit on the sidelines if oil drops below $85 per barrel – using the Brent crude price.
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