In earlier articles, I have discussed how Chevron (CVX) is, although slightly undervalued, not the "strong buy" that the Street makes out. One integrated oil and gas company that I believe has greater risk, but higher upside, than Chevron is Suncor Energy (SU). Suncor specializes in the Canadian market, but also has some international exposure. With that said, operational disruptions and less of a global footprint compared to competitors' contributes to significant uncertainty.
From a multiples perspective, Suncor is also more expensive than Chevron. It trades at a respective 10.5x and 8x past and forward earnings while Chevron trades at a respective 7.4x and 7.8x past and forwards. In addition, Suncor also has a dividend yield that is ~170 bps lower than that of its competitor. Ironically, the fact that Chevron has gross margins ~1,810 bps lower than Suncor is attractive to investors since the gap will likely be closed.
Even still, I believe that the bar has been set lower for Suncor, which will result in higher risk-adjusted returns. At the third quarter earnings call, Suncor's CEO, Rick George, noted several milestones:
So if you look at the quarter, we had record oil sands production of over 325,000 barrels a day, record operating earnings of almost $1.8 billion and a record cash flow of over $2.7 billion. So obviously, our base operations are performing very well. We came out of, if you’ll remember that significant turnaround quarter, the second quarter, and have produced very reliably through the third quarter. We also managed to get to the bottom of our hydrotreating issues and having been experiencing -- that we experienced in the first quarter end, that little bit in the second quarter, and started to maximize our higher-value sweet production towards the end of the third.
We recently set a record production for in-situ…; continued also with outstanding performance in the downstream with 97% utilization rates and over $2 billion of cash flow from operations generated year-to-date. We also had great strong contributions from our Exploration and Production group, which also have the $2 billion year-to-date cash flow from operations.
The firm declared force majeure in Syria, where it is suspending dealings with the General Petroleum Corporation. This was due to sanctions by the EU recently and will result in a temporary loss of its 18 kboe/d production. Even still, production in Lybia is normalizing following political unrest and the company is maintaining guidance for average 2012 production 530 - 580 kboe/d. With 316MBbl/d average November oil sands production, the firm will easily meet at leas the low-end of target projections. And on the financial side, management is on track to clear off net debt and de-risk some of the business.
From a multiples perspective, Suncor's EPS is expected to grow by 98.2% to $3.37 in 2011, decline by 3.3% in 2012, and then grow by 19.3% in 2013. Assuming a multiple of 11x and a conservative 2012 EPS of $3.15, the rough intrinsic value of the stock is $34.65, implying 30.2% upside. If the multiple were to decline to 8x and 2012 EPS turns out to be 8.9% below the consensus at $2.97, the stock would fall by 10.7%. Accordingly, I find that Suncor has overall favorable risk/reward and merits its "buy" rating.
Chevron, on the other hand, comes with much less risk. For one, the firm is less vulnerable to low crude oil prices and regulatory headwinds given its scale. In addition, Chevron has a stronger brand and more comprehensive global footprint that hedges against developed market stagnation. On the capital side, Chevron's two Australian LNG plants also represent attractive catalysts as they ramp up production to 3.3 mmboed. Finally, a more generous capital allocation policy naturally attracts investor entry.
Consensus estimates for Chevron's EPS are that it will grow by 47.7% to $13.84 in 2011, decline by 6.5% in 2012, and then grow by 3.3% in 2013. If the multiple were to hold steady at 7.4x - it should expand - and 2012 EPS turns out to be 4.7% below the consensus, the stock would only decline by 8.5%. Thus, while the firm has less risk than Suncor, in my view, it also has less upside.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
