By Cagdas Ozcan
Suncor Energy (SU) is one of the largest integrated energy companies in the North America. Formerly known as the Suncor Incorporation, this Canadian energy giant was founded in 1953. While the company operates in several locations around the globe, its primary oil fields are concentrated in the Canadian oil sands. The company also operates four refineries in the U.S. and Canada. The company recently reported its 2013 first quarter results. It recorded strong operating earnings of $0.90 per common share which is 6 cents higher than the first quarter of 2012.
As of the time of writing, Suncor stock was trading at $29 with a 52-week range of $25.95 - $35.82. It has a market cap of $44.6 billion. Trailing twelve month [ttm] P/E ratio is 16.4, and forward P/E ratio is 9.5. P/B, P/S, and P/CF ratios stand at 1.2, 1.2, and 5.2, respectively. Operating margin is 13.1%, and net profit margin is 7.2%. The company does not have any significant debt issues. Debt/equity ratio is 0.3. Suncor is an okay dividend payer. Based on the latest dividend of $0.13, projected yield is 1.74%.
Suncor has a 5-star rating from Morningstar. Out of 19 analysts covering the company, 15 have buys, 2 have outperforms, and 1 has a hold rating. Wall Street has diverse opinions on Suncor's future. Average five-year annualized growth forecast estimate is 15.1%. This is a pretty bullish, yet reasonable estimate. What is the fair value of Suncor given the forecast estimates? We can estimate Suncor's fair value using a discounted earnings plus equity model as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($1.75 + $3.23) / 2 = $2.49
Wall Street holds diversified opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 15.1%. Book value per share is $26.25. The rest is as follows:
Fair Value Estimator
Fair Value Range
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for Suncor is between $43.5 and $69.8 per share. At a price of $33, Suncor is undervalued by at least 50%.
Energy companies tend to be undervalued, and Suncor is no exception. The company is trading at a substantial discount to its fair value. It is one of the few energy stocks that still could not recover from the subprime recession. Before the subprime recession, Suncor was trading for as high as $64, which is more than double its current price. The company does not have any substantial debt issues, and its liquidity seems strong.
The recent earnings report also suggested some good news for shareholders. Suncor's management decided to boost its quarterly dividends by almost 50%. It will pay 20 cents in June 25 to shareholders of record on June 4. That will bring the forward yield to almost 2.7%. The company also announced a massive buyback program which will allow buying up to $2 billion of outstanding shares. Those are good reasons to be bullish.
Analysts are also pretty positive on the company. Their mean target price of $41.85 imply almost 40% upside potential in near term. Suncor has the "resources, assets, the balance sheet, and the strategy" to achieve this target. Its refining and marketing segment reported record revenues in the last quarter. The company also agreed to sell a significant portion of its natural gas business in Western Canada. This will bring in additional revenues for this year. I think Suncor is likely to test its previous highs in 2012. Therefore, I rate it as a buy for 2012. The current price offers a compelling entry point for those interested.