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Summary

  • Trading at an attractive valuation due to environmental and infrastructure concerns.
  • History of dividend increases, current yield of 2.50% with payout of $0.83.
  • Significant exposure to the Canadian Oil Sands and the Norwegian North Sea.

Investors looking for an independent E&P company situated north of the 49th should take a look at Suncor (NYSE:SU), a Calgary based company currently trading at attractive valuation, offers a solid dividend and decent exposure to the Canadian Oil Sands. As the chart below indicates, the stock has been flat since 2009, so it is ready to perform?

Suncor Energy Inc produces refinery feedstock, diesel fuel and by-products by developing its resource leases in the Athabasca oil sands in northeastern Alberta and upgrading the bitumen extracted at its plant near Fort McMurray, Alberta.

As the map below indicates, Suncor has operations in Canada, the U.S., the North Sea, Norway and Libya.

(click to enlarge)
Sourced by Suncor

Oil and gas integrated companies such as Suncor typically have an EV/EBITDA ratio that trades in the 5x to 7x trading range.

In this case, Suncor's enterprise value (EV) trades at a discount.

EV = Market Capitalization + Total Debt - Cash and Cash Equivalents

  • EV = $47.69 billion + $11.458 billion - $5.202 billion = $53.946 billion
  • EV = $53.946 billion
  • EBITDA = $12.567 billion
  • EV/EBITDA = 4.29

As oil and gas integrated companies often trade in the 6.53 range, an EV/EBITDA ratio of 4.29 indicates at current levels the stock is trading under fair value compared to other companies in its sector.

Suncor also has a P/B of 1.3, below the industry average of 1.35, and a P/FCF of 5.43, which is below the industry average of 5.81; both of these metrics also indicate the Suncor is undervalued

Why is Suncor Undervalued?

There are a couple of reasons why Suncor is undervalued.

1. Pipeline capacity and Railroad Transportation: According to the Sierraclub, Canada's existing pipeline network can handle 3.6 million barrels per day. At current expansion levels, the article estimates that Canada will hit that capacity sometime this year.

To continue with growth the oil companies are utilizing the rail companies to transport the energy. This method of transportation is also fraught with significant political and environmental issues as well. An Article by the Huffington Post titled, Alberta Train Derailment adds fuel to the pipeline debate, is an excellent example of this issues.

Even though there is much controversy over the Keystone pipeline the company is downplaying the issue. An article by the Financial Post quotes CEO Mr. Steve Williams stating:

The belief is that the industry will get access to markets. It's certainly not constrained our growth and my best estimate would be it's not significantly constrained the rest of the market, either. So I wouldn't expect to see a sudden burst of growth if market access solutions start to appear.

2. Other Environmental Issues Associated with Heavy Oil:

  • The water-based extraction process uses enormous water inputs, requiring between two and four barrels of water for each barrel of oil produced.
  • The oil sands industry also uses large quantities of energy and produces massive amounts of waste water, known as tailings.

Production and Growth

From earlier in 2013, Suncor cut its production guidance to 525,000-570,000 oil-equivalent barrels a day. This is down from 565,000-610,000 barrels due to political unrest in Libya.

The company is expecting production estimates from 400,000-430,000 from the oil sands, 32,000 to 36,000 Syncrude, 53,000 to 58,000 from E&P Canada and 40,000 to 46,000 from E&P International

As production growth is expected increase in 2014, this is expected to have a significant effect on the company's bottom line. As stated by the chart below, analysts at the Nasdaq are anticipating significant growth in 2014.

As the chart indicates, analysts are predicting significant growth over the next 5 years averaging ~10%.

Key Ratio

Return on capital employed = EBIT / (Total Assets - Current Liabilities)

This ratio indicates the efficiency and profitability of a company's capital investments. The higher the percentage the better.

ROCE should always be higher than the rate at which the company borrows otherwise any increase in borrowing will reduce shareholders' earnings, and vice-versa. A good ROCE is one that is greater than the rate at which the company borrows.

  • 2011 = $7.540 billion / $64.467 billion = 11.69%
  • 2012 = $5.063 billion / $66.864 billion = 7.57%
  • 2013 = $7.483 billion / $67.709 billion = 11.05%

According to the list above, all of Suncor's calculated return on capital employed ratios are higher than the rate at which it has borrowed. As compared to the current WACC of 7.29%, this indicates that the company is making profits on the capital invested.

In 2014 Suncor is expecting to increase their ROCE up to ~15%.

Dividend

As the ROCE above indicates, Suncor is creating profits on the capital they have invested. This is of utmost importance to the investor as industry growth and commodity pricing is expected to be volatile over the next few years.

At current levels Suncor offers a 2.50% yield which equates to a payout of $0.83. As the payout ratio is 29.00%, this indicates that the company is not overpaying based on their income. With a history of dividend increases this looks to be an attractive long-term investment.

(click to enlarge)

SU Dividend data by YCharts

Forward P/E to create a target

To create a target price for Suncor. I will use Suncor's forward P/E ratios with estimated earnings to find a target. Currently, Suncor has a forward P/E of 10.35 and FY 2016 high earnings projected at $3.31. Based on visible forward-looking metrics, this equates to a 2014 target of ~$34.25.

As of March 21th, Suncor was trading at $32.54. Using the forward P/E model, this indicates that the stock has a 5.26% potential upside from this point.

Conclusion

As far as stock price is concerned 2014 has not been favorable to Suncor as it continues to underperform. As the price has declined over the past four months or so, I believe the stock is now well below fair value. Currently, the company offers a dividend of $0.81, or a yield of 2.50%, coupled with strong history of dividend increases. As I own the stock for the dividend and long-term Oil Sands exposure I would like to see some capital appreciation. Having stated that, over the next year or so I do not see much, if any. At this point in the market, I have a price target of ~$32.54 for 2014.

Source: Suncor: Trading At Attractive Valuations, But Is It Ready To Perform?