I admire Warren Buffett -- not just because has been a billionaire for decades. And not just because he is giving all of his tens of billions back to society, setting an example for other rich old dudes to follow.
I admire Buffett because he has such a massive Rolodex of companies in his brain that he can quickly refer to in order to take advantage of market inefficiency. As I get more experience investing, I realize how much easier it is to take advantage of market mispricings if you know the companies before they sell off. If you are already an expert in a given sector, when a sell-off occurs you then don’t have to quickly move in and try and learn the companies. If you already know the companies and what you think they are worth you can buy with conviction while others try and figure out what is going on.
How many companies do you think Buffett has in his head for which he has read the last 25 years of annual reports? The banking sector sells off; Buffett opens up his Rolodex and finds Wells Fargo (WFC). The market loses interest in high-quality companies; Buffett buys all the Coca-Cola (KO) he can afford.
I’m obviously a far cry from Buffett. But I’m building my Rolodex of companies slowly but surely. Every year I’ve added another bunch of companies where the work I’ve done gives me an advantage over Mr. Market. Most of the time the companies in my Rolodex won’t be selling at a significant discount to intrinsic value. But when Mr. Market gets emotional and the share price of one of these companies drops, I’ll be a step ahead in determining whether the selling is for a legitimate reason or if it presents an opportunity.
One company in my rolodex that I have followed for quite some time is Canadian Oil Sands (OTCQX:COSWF). Most of the time the company is pretty reasonably valued, and I’m not particularly interested in buying. But as of today, Canadian Oil Sands is out of favor with Mr. Market, and I think that presents opportunity.
Canadian Oil Sands Ltd – Pure Oil Play
Canadian Oil Sands Ltd is, not surprisingly, a pure play on Canada’s oil sands. All production and reserves are 100% oil based. This is a company for oil bulls who don’t have reservations about investing in an oil sands producer.
Canadian Oil Sands Ltd fully upgrades 100% of its production into light, sweet crude oil and is completely unhedged. There are few if any oil producers as leveraged to the price of oil as Canadian Oil Sands Ltd. From a recent company presentation cash flow per share was provided at various oil prices:
$75 WTI - $2.75 cash flow per share
$90 WTI - $3.75 cash flow per share
$105 WTI - $4.75 cash flow per share
$120 WTI - $5.75 cash flow per share
If you want exposure to higher oil prices, COS is a good choice for you. When oil goes up, cash flow per share for Canadian Oil Sands Ltd goes up faster.
Canadian Oil Sands Ltd – Very Clear Valuation Metric
Canadian Oil Sands Ltd is a simple company to understand, and that is good, because otherwise I wouldn’t be able to value it with any confidence. Canadian Oil Sands Ltd only owns one asset: a 36.74% interest in Sycrude, which is an oil sands producer.
In 2010 Conoco Phillips (COP) sold its 9.03% interest in Syncrude Chinese company Sinopec (SHI) for $4.65 billion. Applying this valuation to Canadian Oil Sands Ltd’s 36.74% interest in Syncrude results in a valuation of $38 per share after backing out $500 million of net debt.
Compare that to the current share price and it appears that there is almost 60% upside to reach that valuation target -- and investors get paid a dividend yield of over 5% while they wait for the valuation to be realized.
I think it is important to note that at the time Sinopec purchased the Conoco stake, oil prices were hovering either side of $70. Today WTI is around $90, and for the rest of the world $110 oil is the price of the day. If anything, the asking price for a share of Syncrude has increased since the Sinopec deal.
High-Quality Resource Base
The Syncrude oil sands project is a mining project, not a deeper deposit that requires SAGD technology for production. That has several advantages:
- Predictable, higher recovery rates of around 90%
- No exposure to natural gas prices, SAGD is natural gas intensive
- Lessened natural gas exposure also lessens exposure to potential for carbon taxing
- SAGD producers typically do not have an upgrader, and therefore are exposed to widening of heavy and light oil prices
The Syncrude reserves are also very long-lived, which should mean they are sold into higher and higher oil prices going forward. Independent reserve auditors estimate that the Syncrude proven and probable reserves have a 44-year life at current production rates. There are unbooked contingent and prospective resources beyond that which should significantly extend that window.
Two Measures To Significantly Increase Production Rates
Bringing production forward is a simple way to increase the present value of future cash flows. There are two plans to do this for Syncrude:
- Historically Syncrude has operated at about 85% of full capacity because of regularly recurring, unplanned outages. Increasing to close to 100% capacity would increase cash flow per share for Canadian Oil Sands Ltd by 30%. The plan to get there involves bringing in the expertise of Imperial Oil (25% Syncrude owner), which as a subsidiary of Exxon may be able to sort out the challenges.
- Increasing productive capacity by 50% by opening two currently undeveloped leases at Aurora South to production. The bitumen quality on these leases is similar to what Syncrude is currently producing, and the plan would be to have this big step change in place fully by 2020.
Simple Investment – Hopefully Solid Results
Most of the time Canadian Oil Sands Ltd has sold for over $30 per share, which is a decent but not exceptional value proposition. I’ve been watching and waiting, and now have an opportunity to buy a very easy-to-understand company at a very attractive price. If you think oil prices are headed lower, then I’d avoid this company. If like me you think oil is headed up over the next decade, Canadian Oil Sands Ltd might be a place to start trying to profit from it.