Canadian Oil Sands Looks Attractive Despite Near Term Risk

We are committed to the belief that Canadian Oil Sands Trust (COSWF.PK) is an attractive long-term investment despite suspending our buy recommendations for near-term financial market price risk.

Meanwhile, estimated Net Present Value of US$57 a unit remains reasonable should long-term oil price fluctuate around US$100 a barrel. On oil futures settlement prices as of September 11, we estimate that the current quarterly distribution of C$1.25 a unit would be maintained for the next four quarters indicating a distribution yield of 11.7% a year. Operations for the past three months at 347,000 barrels daily or 99% of capacity support our estimate for next year. If the price of oil declined to $80 for the next year, coincidentally near the economic breakeven price for new projects like Syncrude, management might take the quarterly distribution back to C$1.00 a unit. The Distribution Yield would drop from 11.7% to 9.4% a year, hardly enough of an impact to warrant a stock price decline to under US$40 a unit, in our opinion.

Weekly Income Stock Valuation
Lower stock prices mean more attractive value measured by a median McDep Ratio of 0.75 for thirteen income stocks. The median unlevered market cash flow multiple (EV/Ebitda) at 8.8 times has changed less as both the numerator and the denominator fluctuate with market conditions. Median estimated distribution yield is a high 10.1%.

Originally published on September 12, 2008.

Comments

[NOWHEREMAN:]

when does it become a buy then? You have all of these compelling reasons but do not recommend it.

Why bother to bring it to my attention if you neither own nor recommend its purchase? At what level would you buy it?

IMHO, when the yield approaches 20%, I would consider its purchase, not before. There are enough trusts already yielding that much for me to bother with a stock that yields 11% and which may suspend the entire dividend when the CanRoy Law becomes effective in 2011 suspending their current status.

2008 Oct 06 08:40 AM

[Ferdinand E...:]

"...should the long term price of oil fluctuate around $100/b". There are two questions here: what is meant by "long term", and are the people with the big deposits of oil as intelligent as the people in this forum? If the answer to the last question is yes, then after the finance-market mess is cleaned up, $100/b will be the lower boundary/limit of the oil price.

2008 Oct 06 09:22 AM

[Shiv Kapoor:]

I believe energy sector fundamentals are very sound; however valuations have long over-shot fundamentals. And where the value gets good could lie well below where we see them today. What I do not like about Canadian Oil Sands (not the Trust - I am speaking of the source of oil) is the marginal cost of production (near $80/bbl). The big risk here is that if ultra deepwater discoveries in Brazil, Angola, Gulf of Guinea or US GOM start flowing, you will have incremental supply with a marginal cost of production of $50-$55. This is where I see the oil prices trending down to in the event of a protracted economic contraction - my expectation is $75 with dips to $50-$55 on utter pessimism. For the Canadian Oil Sands Trust I have no idea what their marginal cost of production is - this will have a fundamental impact on valuation of their extractable resources.

2008 Oct 06 10:32 AM

[NOWHEREMAN:]

Don't forget that their operation is highly carbon intensive, the environmental cleanup has yet to be started and they use Nat. Gas to extract oil.

Their future costs will climb and margins decline in a flat to lower price oil environment.

2008 Oct 06 12:35 PM

[Steven Ward:]

Wulf should be hailed for conjuring up his Mcdep ratio. However, like all measurements it is a snapshot in time. The weakness in McDep ratio is an assumption of the price of a barrel of oil. This assumption is somewhat static, as it needs to be, for investment valuations.
The weakness is the volatility of oil itself as well as gas.
I think after today, the "theoretical" price of oil will have to change for valuation purposes. The 6 year futures will change as well.
Thus, a lower Mc Dep ratio, which is usually a
"'buy" may actually become a "sell" or a "neutral", like COS is now due to a re-adjustment of the price of a barrel of oil.
Additionally, all Canroy's will face the possibility of lowering their payouts if oil continues to slide, increasing debt or shareholder dilution if they do not lower payouts.
Gentlemen, you are not alone in stretching for yield, the whole world wants higher yield. But it has a price if un-successful in the economic fundamentals. For Canroy's that is the price of oil vs. their costs. One is comming down and the other is not.

2008 Oct 06 01:32 PM

[Steven Ward:]

Added note: I own Crescent Point energy trust and I'm now wondering why I didn't follow my own maxim of "if you have 5 years woth of non-compounded yield in cap gains, always sell." No matter what.
I guess I'll ride it down with everbody else.

2008 Oct 06 01:45 PM

[Caltorguy:]

Their costs are coming down - nat gas is a main input and its price has dropped from $14 to $7. AB is studying building a nuke reactor to fuel the oil sands. Let's hope they do!

2008 Oct 06 05:31 PM

[NOWHEREMAN:]

A nuclear reactor in the middle of an oil field? The environmentalists will have a field day with that.

2008 Oct 07 12:27 AM

[Dividends A...:]

Any oil sands linked equity is going to trade in sympathy over the short-term with the price of oil. That's the bottom line and until we find some rational support for oil prices with a stable medium term price for investors to objectively evaluate these stocks the volatility will be high.

2008 Oct 07 01:55 PM

[Matt Blackman:]

Kurt;
Do you have any information on the price threshold at which oil sands projects become non-profitable? I heard one analyst say that threshold is around $70/bbl on average...

2008 Oct 08 12:28 PM