Suncor Is A Strong Buy On Much Improved Cash Flow Profile
- Company's breakeven is WTI = $40/bbl. At WTI over $50, it's a cash flow machine.
- First oil from the Fort Hills project is expected before year-end (98,500 bpd net).
- Strong FCF growth bodes well for shareholder returns. My 12-month price target is $42 with significant dividend increases to boot.
Suncor Energy (NYSE:SU) is currently a compelling investment opportunity. The Q3 EPS report was bullish, production is at record highs, the FCF profile is excellent, it has a strong balance sheet, and its breakeven price is WTI = $40/bbl. As a result, there is significant room on the upside for both the stock price and the dividend. Over the next 12 months, I have a $42 price target, and the dividend could easily grow by 10%. The stock currently yields 2.9%. Being a dividend-paying corporation, U.S. investors holding SU in a qualified retirement account are exempt from the Canadian foreign tax on dividends.
The Q3 EPS report was bullish. Highlights:
- Record oil sands production and high refinery utilization generated $2.5 billion in cash flow.
- Net earnings were $1.29 billion ($0.78/share).
- Oil sands operations cash operating costs were $21.60/bbl - the lowest in over a decade.
- The Fort Hills project is 95% complete and is on schedule for first oil by the end of this year.
I have highlighted two often overlooked metrics on the consolidated balance sheet below:
Source: Q3 report (available here)
Investors often regard Suncor as simply the largest oil sands producer in Canada. And of course this is true. However, many investors are unaware that Suncor operates Canada's largest refining and marketing business and has a refining capacity of 462,000 bpd. Note that 58% of the company's total YTD net income was generated by the R&M segment ($1.772 billion). I covered SU's refining operations in more detail in this Seeking Alpha article.
The second metric is simply that Suncor is a free cash flow machine with WTI over $40/bbl (it closed Friday at $55.64/bbl). YTD Suncor has generated $3.76 billion in discretionary free cash flow. With 1.656 billion shares outstanding, that's over $2/share of FCF generation over the first nine months of the year.
Funds from operations this year are estimated to hit $8 billion. Yet cap-ex and dividend obligations are only ~$5 billion. On an annual basis, and given WTI at $55/bbl and the current refining crack spread, Suncor could generate $9 billion in FFO. Obviously there is significant room for share repurchases and dividend increases.
Some of the incremental yoy financial improvement was due to Suncor's counter-cyclical investments in buying out Canadian Oil Sands, and it increases its stake in Syncrude even further by picking up an additional 5% stake from Murphy Oil (MUR).
But much of the financial success of Suncor has been its ability to reduce cost:
As shown on the graphic above, oil sands operating costs have dropped an eye-popping $13.40/bbl since 2012. To put this into perspective, Q3 production from oil sands operations was 628,400 bpd. So the cost reductions equate to a savings of over $8.4 million per day (or $757,000,000 on a quarterly basis). Note that Suncor continues to benefit from a very low natural gas price in western Canada. Natural gas is a major feedstock for oil sands producers.
Source: Natural Gas Intelligence
Meantime, Suncor is expected to grow production by ~8% through the end of the decade, spearheaded by the Fort Hills project. Suncor is the operator of Fort Hills and has a 50.8% working interest. Total (TOT) has 29.2% stake in Fort Hills and Teck Resources (TECK) a 20% interest.
Summary & Conclusion
Suncor is an out-of-favor stock with tremendous upside potential in the given oil, natural gas, and refining price environment. Despite the commodity price downturn, the company has emerged with an A- credit rating (S&P) and a significantly larger ownership stake in Syncrude production. Total debt-to-cap is 26% while net debt to FFO is a relatively low 1.6x given the major acquisitions the company made during the downcycle. The company is expected to grow production by ~8% through 2020 and has only $1.7 billion in debt due during that time frame.
A much improved cash flow profile means investors should expect accelerated dividend growth and substantial share buybacks. Strong growth in EBITDA, cash flow, and EPS next year - driven by Fort Hills and improved up-time metrics - should propel the stock back to highs not seen since 2014. I have a 12-month target of $42/share. The dividend could grow to $1.20/share. The stock currently yields 2.9%.
This article was written by
Analyst’s Disclosure: I am/we are long SU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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