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In an earlier article here, I promoted Suncor Energy and since then the stock has hit my price target - rising by 31.9%, beating the Dow Jones by 2,350 basis points. The Street is currently bullish on Talisman (TLM), Suncor (SU), and Chevron (CVX), but prefers Talisman the least due to operational challenges and failed execution. Based on my multiples analysis and DCF model, I find meaningful upside for both firms especially in the event of a recovery. When factoring in the potential value creation from a strategic initiative for Talisman, I prefer the stock over Suncor

From a multiples perspective, Chevron is the cheapest of these three. It trades at a respective 7.9x and 7.8x past and forward earnings. Suncor and Talisman trade at a respective 10.8x and 12.6x forward earnings. In addition to being the most undervalued, Chevron also has the largest dividend yield at 3.1%. Even still, Talisman's dividend yield of 2.2% is still notable being that it is nearly double that of Suncor.

At the third quarter earnings call, Talisman's CEO, John Manzoni, noted the challenges at North Sea:

[W]e saw both cash flow and underlying earnings from operations increasing substantially from this time a year ago. Cash flow at $902 million was 29% up on a year ago, and more or less equal to last quarter. From a year ago, it was driven largely by higher realizations with slightly lower volumes in an absolute sense. Earnings from operations, which as you know, strips out the various one-off items, was up about 38% from a year ago to $165 million, with largely the same drivers as the cash picture. Operating costs were higher this quarter than a year ago, but more or less the same as the second quarter. Versus a year ago, they were higher in Asia, where some work to manage downhaul scale in PM3 caused an increase, and in the North Sea, where fuel gas was more expensive than a year ago. Unit cost in the North Sea were particularly impacted this quarter by the lower production there during the quarter.

North Sea complications disrupted the CEO's focus on slashing F&D costs to establish greater certainty to growth. Until around last spring, the company was making progress at North Sea. In my view, the firm would substantially attract back investors by announcing a strategic split based around operations. It should consider also selling off its domestic shale gas business to help streamline production. Production is estimated around 443 kboe/d in 2012. As for financial shape, net debt is anticipated to more than double off of 2010 levels by the end of 2013. Reducing leverage would de-risk the company and help win back investors.

Consensus estimates for Talisman's EPS forecast that it will grow by 132.4% to $0.79 in 2011 and then by 21.5% and 35.4% in the following two years. Modeling a CAGR of 56.4% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $15.78, implying 26.4% upside.

Suncor had a stellar conclusion to a stellar year with 325K barrels worth of oil sands production and record cash flow exceeding $2.6B. Furthermore, the company is much less exposed to political instability than what the market makes out - only 3% of cash flow comes from Libya and Syria. Moreover, in the former, Harough has actually brought production back on stream at three-fifths of operations. In the latter, the company has declared force majeure. Suncor continues to be attractive in light of its low-cost E&P portfolio and catalysts at Eagle Ford and the Beta field off of Norway.

Consensus estimates for Suncor's EPS forecast that it will decline by 7.8% to $3.33 in 2012, grow by 20.4% in 2013, and then decline by 3.7% in 2014. Assuming a multiple of 11x and a conservative 2013 EPS of $3.94, the rough intrinsic value of the stock is $43.34, implying 23.5% upside. Even if the multiple were absurdly to plummet to 8x and 2012 EPS turns out to be 6.2% below consensus, the stock would fall by 14.3%. Accordingly, Suncor has very favorable risk/reward.

Source: Why Talisman Is More Undervalued Than Suncor