Suncor Continues to Profit From the Oil Sands

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Continuing tensions over Iran’s nuclear development is pushing oil prices ever higher. West Texas Intermediate crude and April Brent crude closed Friday at $109.77 and $125.47 per barrel, respectively, both at or near nine-month highs. Meanwhile, the U.S. economy continues to pull itself out of a deep hole, and consumer confidence is holding firm, suggesting oil prices have nowhere to go but up.

One company that will benefit from rising oil prices is Suncor (NYSE:SU), best known for its oil sands business in northeast Alberta, Canada. Although its stock is up 26% year-to-date, I believe this is only the beginning of a much bigger move. Read on and I’ll explain why.

Oil Sands

Approximately 55.8% of Suncor’s daily production (546,000 barrels of oil equivalent) is from its oil sands operations in Alberta. In 2012, it plans to produce between 325,000 and 355,000 BOE per day from the oil sands and between 530,000 and 580,000 BOE/D overall. If Suncor were to hit the top end of its estimate for the oil sands and the low-end for total production, the oil sands would represent 67% of its daily production.

An ongoing concern investors have with oil sand producers is the high cost of mining the sands, extracting the bitumen from those sands and refining it into oil — the argument being that companies like Suncor are only competitive when oil prices are high.

Suncor’s current oil sand operating costs are about $35 per barrel. In 2011, its average price realization per barrel was $88.74, 28% higher than in 2010. That’s likely to be higher once again in 2012. Since the beginning of 2005, the West Texas Intermediate crude oil spot price hasn’t traded below $50, with the exception of a six-month period between November 2008 and April 2009.

The company’s oil sands generated $2.6 billion in net earnings in 2011 on a 21.3% margin, 440 basis points higher than the year before. Given Suncor’s operating costs per barrel in 2012 should be lower than this past year, the oil sands’ net profit likely will be at least $1 billion higher.

Shareholder Value Creation 

If you had invested $100 in Suncor on March 18, 1992, that investment would have been worth $4,063 at the end of 2011. The same $100 invested in the S&P 500 was worth $375. While that’s a great stat, it’s in the past. However, companies that routinely deliver shareholder value usually continue to do so. Therefore, it’s important to understand how they deliver that value.

For instance, one way to deliver value is possessing a strong balance sheet. In 2011, Suncor reduced its net debt to $7 billion from $11.3 billion in 2010 — a 38% reduction. Net debt is now 0.7 times cash flow from operations, the lowest it has been since 2006.

A second way Suncor delivers value is through its return on capital employed. Excluding its major projects in progress, Suncor’s ROCE in 2011 was 13.8%, 240 basis points higher than at the end of 2010. Again, it hasn’t been this high in several years.

On Feb. 23, Suncor announced that it would purchase an additional $1 billion of its stock between Feb. 28 and Sept. 5. In the last four months of 2011, Suncor repurchased 17.1 million shares at an average price of $29.19. Its closing price on Feb. 24 was $36.96, giving shareholders a 27% return on its $500 million investment in just six months.

Unfortunately for shareholders, Suncor management could have done better. It paid just 13% less than its high of $33.40 in those four months. A better use of the funds would have been to repay debt or save the money for a decent-sized special dividend. Besides buybacks, dividends are another way management can return cash to shareholders.

In 2011, Suncor paid out $664 million in dividends, raising the quarterly amount 10% in the second quarter to 11 cents per share. Overall, the company paid out 36% of its free cash flow to shareholders in 2011, which is a healthy amount given some of the projects it will undertake (such as the Fort Hills and Joslyn oil sands) in the next few years.

Bottom Line

Since Suncor acquired Petro Canada in 2009, its stock price hasn’t spent much time below $30. There’s a good reason for this. While the oil sands is where Suncor’s growth will come from, its refining and marketing business provides it with stable revenue in any type of economy or pricing environment. And investors like stability.

Suncor’s current valuation is below its five-year average in terms of P/E and other metrics. Although I wouldn’t categorize it as cheap given its run so far in 2012, unless Suncor has a colossal blunder in the next couple of years, the upside potential still appears to far exceed the downside.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.


Article printed from InvestorPlace Media, https://investorplace.com/2012/02/suncor-su-continues-to-profit-from-oil-sands-energy-stocks-to-buy/.

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