Suncor Energy Inc. (SU) Analysis – Monthly Patron Pick
Suncor Energy Inc. operates as an integrated energy company and is based out of Canada. Another Canadian stock like our good ole KL, ay?
Their operations include oil sands development, production and upgrading; offshore oil and gas; petroleum refining and our national Petro‑Canada™ retail distribution network (now including our Electric Highway network of fast-charging EV stations).
What’s nice to see with a company that generates most of their revenue and profits from oil is that is seems like they are trying to lower emissions and shift some of their business into renewables and diversify their energy portfolio.
In my eyes that is good, because if you go far enough in time we will need to focus on renewables as a global society or figure out how to be way more efficient.
This is a large cap stock with a market cap coming in around $37 billion. I would classify this as a cyclical play based on it’s industry in mostly oil related exploration and production.
The timing on this analysis came right on the day of Q3 earnings andddd the company crushed it as you can tell by that 1 day % gain in the chart above. Which is good or bad depending on if you already own the stock, but the good thing is we get the freshest look at the financials and updated guidance.
Looking at the YTD returns of around 35% it has benefited from the large increase in crude oil pricing and seemed to have a larger pullback than oil itself back in August but since then has recovered and is closer to 52 week highs that weren’t seen since June.
YTD price of crude oil
This chart and story is going to be similar for a lot of integrated energy companies with a focus on oil as it is the commodities business that tends to follow the economy and pricing.
Good management though can help avoid troubles during hard times and be able to take advantage of the boom years.
With any commodity business it’s all about supply and demand. What is the projected demand for the commodity in the future and how much capacity is out there to produce it. Oil is a big big market so there are lot’s of players out there.
The one thing I don’t love is that OPEC has a large control over the supply side. If your not familiar with that term, OPEC includes countries with some of the world’s largest oil reserves. As of the end of 2018, OPEC members controlled about 72% of total world proved oil reserves, and in 2018, they accounted for 41% of total world crude oil production.
So a lot of oil companies are at the will of this group as they can manipulate supply to a certain degree, but if they play nice everyone in the market can benefit. Regardless let’s talk about the demand side.
“Increase In Demand : From 2806.9 million USD In 2020, The “Crude Oil Market” 2021 will register a 2.3% CAGR in terms of revenue Over the next five years and the global Market Size will reach 3289.9 Million USD by 2026.”
At this point oil is consistently in demand and slowly rising. In 2020 there was a massive dip caused by the pandemic, but 2021 has been a large rebound as economies are reopening. With that the expected demand for oil is supposed to continue to grow to a certain point. When you might ask?
According to the International Energy Agency, demand of oil will peak in 2025 which I think may be a little early from my own point of view. OPEC thinks demand plateaus more around 2035 which I think is more realistic as the world is still very dependent on oil. But the point isn’t what year oil peaks, it’s that these companies over the next 20 years need to shift their business model.
As pointed out in the business model above the company is trying to shift some of it’s business to lower emissions and renewables.
My view on the oil markets and investing in cyclicals is to be in and out over a couple year time frame and get out when things start to turn. I say this because I think commodities can do well going into 2022 (at least 1st half of the year) and that is how I am positioned with my steel/oil positions. I want to ride the wave and when pricing and capacity catches up to demand then it may be time to move that cash somewhere else as they have captured a ton of upside movement from the pandemic recovery.
Below is the business cycle chart showing the best sectors to be invested in based on the current cycle.
The energy sector does well in the mid to late stages of of economy growth. Which I believe we are around that mid area.
According to fidelity, they believe Canada is in the late stages of recovery and moving towards peak growth.
I say all this because for a company like Suncor (or any oil company), I am looking at holding for around a year, but don’t want to set it and forget it.
The industry is slowly growing, but eventually will be an industry on the decline. In years of huge price increase these companies can print cash, but it may be short lived.
I should probably make a rule of no companies outside of the US, because all the numbers are in another currency so remember that when I discuss the numbers below that it in Canadian dollars. And I’ll use those for the DCF and valuation piece as well.
Let’s talk Q3 earnings as they are hot off the press!
Suncor Energy (SU) came out with quarterly earnings of $0.56 per share, missing the Consensus Estimate of $0.58 per share. This compares to earnings of $0.15 per share a year ago. Revenue was also a slight miss. Overall thought the EPS and revenue we’re much higher than the previous year.
- In the third quarter of 2021, the company returned $1.0 billion to its shareholders through $704 million in share repurchases and payment of $309 million of dividends, and reduced net debt(4) by $2.0 billion
- Subsequent to the third quarter of 2021, Suncor’s Board of Directors (the Board) approved a quarterly dividend of $0.42 per share, which represents an increase of 100% over the prior quarter dividend, reinstating the dividend to the 2019 level.
It is clear from the above two points the company is highlighting it is paying down debt (fortifying the balance sheet) and returning capital to shareholders via dividends and repurchases while pricing of oil is up. They mention that they are getting their net debt levels back to 2019 levels.
Overall production seems to be flat quarter over quarter, but profits are trending higher which seems to most directly tied with higher pricing. In the Q3 report I don’t see too much mention of these other energy initiatives that are laid out in the strategic leadership goals (so I’m wondering if that is mostly to save face :)).
The company did give us a dedicated section for FY 21 guidance that we can use as a proxy for some of our DCF assumptions.
First they gave was a production guidance for FY 2021 which we can use as a base for our DCF assumption. But honestly, I am not exactly sure how to calculate the expected revenue using these numbers so I’ll have to go ahead with something like fin box as a revenue estimate for FY 21.
Let’s go ahead and plug this and use similar margins to current quarter as a base, but we can tweak the Capex to land somewhere in the middle of the projected range.
With all the above I come up with a projected fair value of $39.41 (remember this is the Canadian stock for current value not the US version at the beginning of this post since I didn’t want to have to convert Canadian dollars to US).
Please see attached model for assumptions. This used a blend of P/S ratio and DCF calculations.
The stock is having a nice breakout and has passed the 52 week high back in June. That is usually bullish and may continue higher due to breaking that resistance.
Risks & Ops
If you couldn’t tell from my tone from above, the biggest risk to this company is pricing of oil. If that falls, this stock will struggle. At the same time if oil continues to climb it will benefit the stock even more so than targeted. So if you are bullish on SU you need to be bullish on oil over the next year at least.
Opportunities would be to divest from oil and build out the other streams of business around renewables and other sources of energy. I just don’t see it in the numbers right now.
I think the stock is undervalued from a fair value stand point based on the analysis and that the market is still hesitant to give these cash flowing businesses a higher multiple.
I am not buying this stock personally, I have my exposure to oil through VDE.