Buy-recommended Canadian Oil Sands Trust (OTC:COSWF) offers unlevered appreciation potential of 55% to a McDep Ratio of 1.0 where stock price would equal Net Present Value (NPV) of US$42 a share. When the next quarterly distribution is declared on October 28, we believe the outlook supports C$0.50 a unit, twice the C$0.25 most recent payment. The increase we envision can be carried by our projection of fourth quarter Ebitda minus Interest of C$0.75 a unit, about the same as an estimated C$0.74 in the third quarter and a more normal level than C$0.14 in the second quarter.
Third quarter volume recovered from the depressed second quarter and management’s guidance calls for operations at 99% of 350 thousand barrels daily (bd) capacity for the fourth quarter. At the same time, a distribution more in line with cash flow may help stock price and thereby raise the initial offer of a potential acquirer who would try to buy at a price as far below NPV as possible. While the distribution increase is our opinion today, the COSWF board will have another month of history before deciding and/or may have different intentions. In any case, we believe that COSWF is a choice long-term pure oil growth investment at an attractive price.
Operations Rebound in Third Quarter
The Syncrude joint venture (37.7% COSWF) produced 340,000 bd of Sweet Premium crude oil in the month of September when there were no unexpected upsets. Continued operation at 347,000 bd would meet management’s guidance of 104 million barrels for the year 2009. Considering the low expectations embedded in stock price, we think actual achievement of that level would be positive for stock price while a shortfall would ratify continued skepticism.
The price discount for Syncrude Sweet Premium compared to the Light, Sweet (WTI Cushing) industry benchmark narrowed to about C$1 a barrel in the latest quarter. We make that rough estimate from data reported by Bloomberg. Our projection of a C$4 discount for the next twelve months is more a means for building in a contingency than what we think will actually materialize. As economic growth proceeds, the discount should become a premium.
Strong Financial Position Supports Normal Distribution Policy
Ebitda minus Interest equal to C$0.74 a unit estimated for the third quarter is an objectively measurable starting point for determining sustainable distribution capacity. From that we mentally subtract another C$0.02, or so, to cover long-term repayment of the trust’s low level of debt. Management subtracts Non-Production expense at the quarterly rate of about C$0.07 a unit from cash flow. That is a conservative step because those outlays are in the nature of research and development that ought to result in incremental improvements in the future that earn a return on current outlays. Management also subtracts maintenance capital expenditures expected to run at the abnormally high quarterly rate of C$0.08 a unit in the next few years. That is also conservative because outlays include amounts for the new “wet crushing” technique of ore processing, which could be considered enhancement beyond normal maintenance.
At the same time management looks to increase debt by C$0.17 a unit for the next five quarters, which can offset Non-Production expense and maintenance capital. Beyond 2010 there are cash income taxes and potential expansion capital outlays to consider. For now we think that a little less than Ebitda minus Interest is an appropriate measure of distribution capability.
Of course, financial conditions were not normal for most of the past year. During those times management felt it necessary to be especially cautious out of concern that normal commercial lending would be completely shut down. With successful recent borrowing in the bond market on terms that require no repayment for several years, the trust has almost eliminated any dependence on banks for short-term financing.
Single Most Attractive Oil Acquisition Target
Personally, we like management’s conservative style, up to a point. We do not want to lose our ownership of a valuable asset because a third party took advantage of a low stock price. COSWF stands out in our research as the most undervalued large cap, pure oil resource. Just as we like COSWF as an investment in a real asset at an attractive long-term rate of return, so might China, as an especially pertinent example. We want diversification in our portfolio from dollar-denominated assets, and so does China apparently. We think oil price is going up; China has a strategic need for the commodity itself and a hedge against the price. On-stream production, expansion potential, long life and relative political stability for COSWF are nice diversifiers to undeveloped resources in politically less stable areas such as Angola and Kazakhstan where China has also expanded.
There may not be too much political objection to China taking a partial interest in Syncrude. Important decisions in that venture are subject to the approval of multiple owners. China has already made modest investments in development stage oil sands companies. Partial ownership of Syncrude would be a window on extraction and processing technology that can have broader application to China and its companies.
At the same time, the Syncrude owners retain the disposition rights to their share of oil. China could swap its share of Syncrude oil for crude anywhere in the world and might have to look no further than a Syncrude partner like buy-recommended Exxon Mobil (XOM) or buy-recommended ConocoPhillips (COP) to do the transaction. If Syncrude oil were to be shipped directly to China eventually, incremental capital investment would be modest. If China wants more Syncrude than owned by COSWF, buy- recommended Suncor (SU) may be willing to part with its share picked up in the acquisition of Petro-Canada.
Stock Price on 50-Day Average
Several times during the past few months COSWF stock bottomed near the 50-day average currently US$26 a unit where it last closed. Though we don’t expect it and can’t know anyway, stock price could fall to the 200-day average of US$22 and still be in an uptrend by that measure. On the upside, we look at the old high of US$56 and consider it a reasonable expectation to surpass that again.
A prospective acquirer may consider similar rationale. The old high shows acquirers the potential payoff. The pattern of recovery from the bottom suggests ”the worst is over”. Bold action now could be timely.
Originally published on October 5, 2009.
Disclosure: McDep or its employees may take positions in stocks the firm covers for research purposes. No trades in a subject stock shall be made within a week before or after a change in recommendation.