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Overview

Suncor Energy Inc. (NYSE:SU) is a major Canadian-based integrated energy company.

Suncor is particularly active in the extraction and upgrade of oil sands in Western Canada.

Suncor trades on the Toronto Stock Exchange (TSX) under the ticker "SU", and also trades on the New York Stock Exchange (NYSE), also under the ticker "SU".

SU is part of the S&P/TSX60 index.

SU is a Canadian corporation and therefore pays its quarterly dividends in Canadian dollars. All the following figures are thus in Canadian dollars.

Notably, foreign investors will likely be subjected to withholding tax.

Dividend Calendar

SU pays a quarterly dividend.

The dividends are generally declared in February, May (or late April), July, and November, and are generally paid in March, June, September, and December.

SU generally increases its quarterly dividend once a year. Still, SU does not happen to have a particular schedule for the dividend increase, at least for now.

The last increase in February 2014 was of 15.0% (from CA$0.20 per quarter to CA$0.23 per quarter).

Dividend History

With the most recent increase, SU has increased its quarterly dividend for 12 consecutive years, making SU a dividend contender (between 10 and 24 years of consecutive dividend increases).

The evolution of the annualized dividend and of its growth over the last ten years is presented in the graph below.

The first thing to note from the graph is that between 2004 and 2005, the dividend appears to have remained flat. However, this is not the case. In 2004, the annual dividend was CA$0.115 and in 2005, the annual dividend was CA$0.12.

However, on most websites, the annual dividends are rounded to the cent. In the case of SU, the 2004 annual dividend was rounded to CA$0.12. That explains the apparent lack of increase between 2004 and 2005.

Otherwise, we can see that the pattern of dividend increases is very cyclical. Years of large dividend increases are followed by years of smaller dividend increases.

This is not very surprising, SU operates in the cyclical energy business.

Still, SU has been able to increase its dividend year in, year out, despite recessions and drops in oil prices. For me, that shows that SU is likely to continue to increase its dividend in the foreseeable future. At what rate? That, I don't know.

Dividend Analysis

In this section, I verify two important aspects of the dividend:

  1. Is the current dividend safe?
  2. Is the current dividend likely to grow?

Understandably, answering no to either one of these questions should mark the stock under consideration as being unsuitable for dividend investment purpose.

Is the current dividend safe?

To determine the safety of the dividend, I check the historical levels, the current level and the evolution of the payout ratio with respect to the earnings and, when relevant, with respect to the free cash flow.

First, the evolution of the earnings, dividends, and payout ratios.

I have not analyzed the evolution of free cash flow as it is not very relevant in the case of SU.

With respect to the earnings, we can see a certain cyclical pattern; years of high earnings are followed by years of lower earnings. Since SU operates in a cyclical business, which is also very capital intensive, such figures are not very surprising. I would prefer a nice upward trend but different industries have different fundamentals.

Despite the ups and downs of the earnings, SU has managed to keep a relatively low payout ratio. In that sense, even during its lowest year, in 2009, the payout ratio still remained under 35%.

In the case of a cyclical business like SU, having a low payout ratio is a good thing as it provides the company a large margin to further increase the dividend, even in tougher years.

In any event, despite the cyclic nature of its business, it remains that SU is in the business of extracting, refining and selling oil. Furthermore, SU is active in one of the largest proven reserve of oil (the Canadian oil sands) and our dependence on oil is not going to go away soon.

So, in my view, SU's earnings are probably going to go up in the future.

Overall, I think the current dividend is safe. The earning payout ratio is low.

Is the current dividend likely to grow?

As we have seen, SU has been increasing its dividend for 12 consecutive years now. Moreover, recent increases have been in the double digit. For me, this is a clear indication that SU is serious about increasing its dividend.

So yes, the divided is likely to grow.

In addition, as mentioned above, SU's earnings are likely to further go up as oil prices trend higher.

In my opinion, the only unknown is at what rate can we expect SU's dividend to grow.

Over the last 10 years, the dividend growth rate has been all over the place. We can probably expect the pattern to remain the same in the foreseeable future.

Overall, I think the current dividend is likely to grow in the foreseeable future.

Stock Valuation

Estimated Fair Values

To calculate a range of fair values, I calculate how much one share will return in cumulative dividends over the next 20 years, according to different scenarios, and adjusted for inflation.

For SU, I've used the following inputs:

  • Share price: $37.00
  • Dividend rate: $0.92
  • Dividend growth rate:
    • Optimistic scenario: 22.0%
    • Realistic scenario: 17.6%
    • Pessimistic scenario: 13.2%
  • Inflation rate: 3.5%

The optimistic DGR generally corresponds to the 10-year average, while the realistic and pessimistic DGRs respectively correspond to 80% and 60% of the optimistic DGR.

According to the above values, the range of estimated fair values for SU varies from $49.08 (pessimistic) to $132.87 (optimistic) with a realistic value of $80.11.

With a current share price around $37.00, SU appears significantly undervalued.

I've also calculated that the DGR would need to be 10.56% over the next 20 years to justify the current price of $37.00.

Notably, a DGR of 10.56% is 20% below the pessimistic DGR and just slightly above the 10-year earnings growth rate.

Hence, I thing that SU is fully capable of maintain an average dividend growth rate of 10% in the foreseeable future.

At $37.00, I think SU is undervalued as a dividend investment.

Estimated Cash Return

With the estimated cash return, I calculate how much cumulative dividends a fixed investment in the stock under consideration will return over a period of years.

Estimated cash return values allow to compare dividend stocks with different yields and different growth rates.

For SU, I've used the following inputs:

  • Initial investment: $1000
  • Current yield: 2.49%
  • Dividend growth rate:
    • Optimistic scenario: 22.0%
    • Realistic scenario: 17.6%
    • Pessimistic scenario: 13.2%

Notably, the DGRs are the same as the DGRs used for valuation.

I also compare the various estimated cash return values with the estimated cash return of a benchmark dividend stock having a yield of 3% and a dividend growth rate of 8% (e.g. Procter & Gamble (NYSE:PG) or Johnson & Johnson (NYSE:JNJ)).

Wouldn't it be great if the optimistic scenario was to occur? Imagine turning $1000 into almost $45000 over 30 years.

Sadly though, I don't think SU would be able to maintain a DGR of 22% over a period of 30 years. Even the realistic DGR is probably unsustainable over such a long period of time.

However, a DGR of 13.2% might be achievable.

At such a rate, a $1000 investment in SU would return about twice as much money as a comparable investment in the benchmark stock. Not bad.

In that sense, I've calculated that the DGR would need to fall to about 9% for an investment in SU to return as much money as a comparable investment in the benchmark stock.

Keeping in mind that a DGR of 9% is way below the recent average DGR, I don't see much downside.

At the current price and yield, I think SU would make a good dividend investment.

Conclusion

SU currently yields a very reasonable 2.49%, its estimated future dividend growth rate is likely to be in the low double digit, its current payout ratio is low under 30% and its share price is likely undervalued (at least according to my calculations).

So, in my view, at the current price and yield, SU would appear to be a sound dividend investment.

In addition, you might like to hear that should you decide to buy some SU shares, you would be in good company.

Indeed, Warren Buffett owns about 18 millions shares of SU.

Final recommendation: I think SU is a buy.

Full Disclosure

I don't currently own shares of SU.

I don't intend to initiate a position in SU within the next 72 hours.

Source: Suncor Energy Inc. - Dividend Fact Sheet