Suncor Energy: Pricing Differential Drags On Results

Summary

• The differential between WCS and WTI crude oil was at its highest levels ever during the fourth quarter of 2018.
• This had an impact on all of Suncor's financial figures.
• The company's refinery operation managed to offset some of the effects of this, but it does not have enough refining capacity to offset it all.
• Despite the poor financial performance, the company hiked the dividend and buyback programs, continuing its streak.
• Since the differential is starting to narrow now, we may see some positive impacts going forward.
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On Wednesday, February 6, 2019, Canadian oil sands giant Suncor Energy (NYSE:SU) announced its fourth-quarter 2018 earnings results. At first glance, these results look rather disappointing as the company failed to meet the expectations of analysts on both the top and bottom lines. At least some of this was expected due to the widening of the differential between Canadian and WTI crude oil, although Suncor's refinery operation does allow the company to offset a large portion of the lost revenue due to this. Suncor also suffered from a few one-time events that had a negative impact on the company's earnings. Overall, I will admit to being somewhat disappointed as I was reviewing these results.

As my long-time readers are no doubt aware, it is my usual practice to share the highlights from a company's earnings report before delving into an analysis of its results. This is because these highlights provide background for the remainder of the article as well as serve as a framework for the resultant analysis. Therefore, here are the highlights from Suncor Energy's fourth-quarter 2018 earnings results:

• Suncor Energy reported total operating revenues of C$8.561 billion in the fourth quarter of 2018. This represents a 4.88% decrease over the C$9.000 billion that the company had in the same quarter of last year.
• Operating earnings were C$580 million in the quarter. This compares very unfavorably to the C$1.310 billion in the prior year quarter.
• Suncor reported an average production of 831,000 barrels of oil equivalents per day during the fourth quarter. This compares to 736,400 boe/day in the year-ago quarter.
• Total funds from operations were C$2.007 billion during the most recent quarter. This compares quite unfavorably to the C$3.016 billion that the company had a year ago.
• Net loss was C$280 million in the fourth quarter of 2018. This compares very unfavorably to the C$1.382 billion profit that the company had in the fourth quarter of 2017.

The first thing that anyone reading these highlights is likely to notice is that Suncor Energy saw its revenues decline substantially year-over-year. This comes despite the fact that Suncor managed to increase its production over the prior year quarter, which usually adds some positive pressure to revenues. Suncor states that the reason for this weakness was a widening differential between West Canada Select and West Texas Intermediate crude oil. This is a problem that has been plaguing Canadian oil sands producers for quite some time and has been a topic in some of my recent writings about these companies. The differential increased dramatically during the quarter and forced the government of Alberta to impose a production cap. The company was certainly impacted by this as it saw its realized price for oil sands production fall to $19.50 per barrel from $43.10 a year ago.

Source: Suncor Energy

Suncor is less affected by this differential than smaller oil sands producers. This is due to the four refineries that the company owns throughout North America. These refineries allow the company to capture world pricing (Brent-based) on a portion of its total production. In the fourth quarter, this portion was 467,900 barrels per day or 63.16% of the company's total oil sands production. This unit actually sees its profits increase when the spread between WCS and Brent crude increases. Therefore, this business unit was able to offset some of the effects of the low oil price, but it was clearly not able to offset all of it because the company's oil sands production of 740.8 thousand bpd/day was more than the refineries could handle.

One of the most disappointing things here was the company's reported net loss of C$280 million compared to the C$1.382 billion profit that the company had last year. While the differential and steep loss of revenue certainly played a role, another one came from a one-off event. As a result of currency fluctuations during the year, the company was forced to take a foreign currency loss of C$637 million. This was because of the impact that the firm's U.S. dollar-denominated debt will have on its future finances and its balance sheet. It is important to note however that this writedown was a non-cash event that did not actually result in any money leaving the company. Even if we do ignore this, the company still saw its profits decline year-over-year, although it still would have made a profit.

The more important measure of the company's overall financial performance is funds from operations. This is essentially the amount of actual cash generated from the company's operations. Unfortunately, this was also somewhat disappointing in the most recent quarter as it was the lowest level that the firm has had over the past year:

Source: Suncor Energy

The reason for this is the same one that has already been discussed. Basically, the simple fact that West Canada Select crude was trading at prices very close to its all-time lows during the quarter and the refinery operation was not able to completely offset the effects of this. Unfortunately for us, this decline in FFO is indeed a problem for the company since this is the money that has to support expansion plans and returns to the shareholders. Fortunately though, now that the Alberta government's mandated production cuts have started to see the province's oil stocks decline and prices firm up, we may see improvements here over the next few quarters.

Despite the overall weakness in the financial numbers, Suncor greatly increased the amount of money that it is returning to shareholders. Following the end of the quarter, the company increased its dividend by 17% to C$0.42 per share and authorized the addition of C$2 billion to its share repurchase program. This continues the company's streak of growing its dividend over time:

Source: Suncor Energy

It is important to note however that this dividend is paid in Canadian dollars. Thus, U.S. investors have not always seen the same degree of dividend growth as currency fluctuations change the amount that is actually received. The overall trend even for these investors though has been positive and Suncor has been a good dividend growth stock among the big oil companies. At the current stock price and exchange rate, the stock yields 3.97%.

In conclusion, this was not a particularly good quarter for Suncor Energy. However, it certainly could have been much worse. The company suffered from the huge price differential between WCS and other crude blends, although its refinery operation did help to mitigate that somewhat. The firm did manage to grow its production somewhat though, and despite the revenue and cash flow weakness, it managed to continue to grow its dividend. The company overall still continues to perform decently given the current environment.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.