The International Energy Agency just raised its estimates for demand growth in 2014 to 1.3 million barrels per day on the back of strong GDP reported by the U.S., as the world's largest economy finds its way out of recession and toward theoretical 'full employment'. Expectations for energy demanded have also been supported by U.S. Energy Information Administration and OPEC. This presents an opportunity of immense potential for Canadian petroleum producing firms which fuel North American energy needs via rail roads and pipelines. This article takes a look at the three best suited oil stocks for your portfolio, keeping in mind the hiccups associated with Keystone XL pipeline.
Suncor Energy (NYSE:SU) is Canada's top petroleum producer and despite political pressure on the Keystone XL pipeline extension, the company will spend $7.45 billion to enhance its oil production by more than 10% in the coming year. The firm's problem for most of 2013 has stemmed from pipeline bottlenecks; for 2014, $1.9 billion will be spent on debottlenecking and expansion projects which will provide a marked improvement in margins and faster turnover time. Side by side, Suncor's management has put out an ambitious plan of cost reduction to enhance shareholder value. The program targets reducing operating costs below $35 per barrel by focusing on reliability and efficiency. Investment in Golden Eagle in the North Sea and development of Hebron on East Coast for exploration and production projects will play a huge part in enhancing Suncor's positive free cash flow at a time of discomfort for Canadian oil producers.
Delays in the completion of key pipelines like the Keystone XL have had a negative effect on Canadian crude oil prices. Environmental activists fear that in case of a leak on the 800,000 barrels of oil per day transporting pipeline, the environment would be affected in a disastrous way. In turn, oil producers have had to suffer transportation limitation and hence, reduced demand. Imperial Oil (NYSEMKT:IMO) is building a crude-by-rail oil terminal in collaboration with Kinder Morgan (NYSE:KMI) which would have an initial capacity of 100,000 barrels per day. Construction is under way and first shipments are expected in 2015 which would significantly increase company's access to the largest refining center on the Gulf Coast. In the last quarter, the firm benefited from increased production due to its Kearl oil sands project and the acquisition of a 50% stake in natural gas producer Celtic Exploration.
The Keystone XL extension is pivotal to the prospects of Canadian oil companies. Currently, the Western Canadian Select heavy crude oil is available at $17 per barrel, its highest level since July last year, as new refinery demand comes online while unfavorable weather contributes to Alberta oil sand production volatility. The price remains low compared to U.S. market prices because of the inefficient and costly transportation measures which do not pass economic feasibility. When Keystone XL does come online though, Canadian heavy crude oil's demand and price would increase incrementally.
Perhaps the biggest beneficiary of this chain of events would be Canadian Natural Resources (NYSE:CNQ); since more than half of the company's current oil production pertains to heavy crude oil. Resultantly, the company would experience a boost in earnings and margins because of higher prices and higher quantity being transported. The firm had also put up its gas assets at Montney up for sale but failed to find suitable buyers and hence, will continue to hold the liquid-rich natural gas reserves of the region.
The table below compares financial performance of the three firms over the past three years. Suncor, being the largest Canadian oil producer also has the largest market cap. The company's net income and revenue have been high volatile over the last three years; in fact, one would think that the oil crisis of 2008 would have contributed to that, but the volatility extends back 10 years from 2013 which goes on to show how big of an effect prices have in this industry. The suggestion is backed by a beta co-efficient value of 1.48, showing highly responsive stock performance to external factors.
Canadian Natural Resources
Net Income Growth (3 Yr Avg.)
Revenue Growth (3 Yr Avg.)
The oil production industry has an average P/E of 29.8. With that perspective, all three companies are undervalued, but according to P/E alone, Imperial oil provides the best value proposition. The PEG ratio evaluates projected growth over the next 5 years and produces a forward looking valuation metric. By its standard, Canadian Natural Resources will be the fastest growing oil firm of the three, which will translate into higher margins and earnings for investors.
Canadian Natural Resources' margins might improve in the future, but they have been subjectively dismal over the past three years. Out of the three companies, Canadian Natural Resources has had the largest revenue growth but its net income growth has been very weak compared to Suncor and Imperial Oil.
Canadian Natural Resources
Dividend Growth (Yr. on Yr.) %
Dividend Yield, %
Payout Ratio %
Free Cash Flow TTM $
Return on Equity TTM
Dividend payout is not this industry's strong suit as evidenced by the breakdown above. The three companies have had highly prudent payout ratios over the past 10 years. Suncor stock is the highest yielding while also showing top growth numbers in absolute dividend amounts. Furthermore, the firm also boasts a positive free cash flow of $1.5 billion for the past 12 trailing months - a feat which had eluded its rivals. Imperial oil and Canadian Natural Resources have clocked negative free cash flow in all four of their previous quarters. The three companies have a similar debt/equity ratio but Imperial oil is apparently utilizing its capital and debt a lot more efficiently as suggested by the Return on Equity metric. Perhaps this is the resultant of the ongoing share buyback program.
What's on the Horizon?
The latest U.S. State Department's review of Keystone XL pipeline found only a 4% risk of a spill larger than 1,000 gallons. Furthermore, the amounts being pumped into the industry are staggering since the U.S. economy moves out of recession and demand continues to pick up. Over the past decade, refineries in the U.S. have been set up to process heavy crude oil from countries like Canada, Venezuela and Mexico export. At the moment, the U.S. imports 40% of its oil requirement.
An impending Canadian crude oil boom is on the horizon due to the increasing domestic demand, along with improved transportation which will provide preference to Canadian oil exports over others. All three firms stand to profit from this development. With the current infrastructure and undergoing projects, Suncor and Canadian National Resources are best placed to take advantage of this boom. The two firms have projects under development which will provide intrinsic earnings growth to shareholders, while currently being undervalued by a large degree.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.