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Suncor: Suffering From Macroeconomic Environment, Growth Likely To Be Stunted

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About: Suncor Energy Inc. (SU)
by: Power Hedge
Power Hedge
Macro, energy, alternative energy, contrarian
Summary

Suncor Energy beat analysts' expectations, which is something of a rarity in the current energy pricing environment.

The company posted production growth YOY, continuing with its trajectory that it established a while back.

The company is unlikely to start up any oil sands projects until oil prices are much higher, so forward growth will be muted.

The refinery operation was a bit weaker than last year, partly due to WCS being much closer in price to Brent than last year.

There are better oil companies for those looking for growth, but Suncor is not a bad choice for someone that just wants stability.

On Wednesday, October 30, 2019, Canadian oil sands giant Suncor Energy Inc. (SU) announced its third-quarter 2019 earnings results. At first glance, these results were somewhat mixed as the company beat the expectations of its analysts in terms of top-line revenues, but did miss their earnings expectations. With that said, the company did beat in terms of non-GAAP earnings and this appears to be the number that most of the headlines surrounding these earnings focused on. This alone makes the company something of a rarity in the energy space as most of the companies that have announced recently have missed analysts' expectations. A closer look at the company's results reveals that the firm has been suffering from the same broader macroeconomic trends as other energy companies but it also continues to execute on the growth story that we have previously presented for this company. This could position it well to prosper when and if oil prices return to normal levels.

As my long-time readers are no doubt well 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 a 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 Energy's third-quarter 2019 earnings results:

  • Suncor Energy brought in total revenues of CAD$9.896 billion in the third quarter of 2019. This represents a 8.90% decline over the CAD$10.863 billion that it brought in during the prior-year quarter.
  • The company reported operating earnings of CAD$1.114 billion in the most recent quarter. This compares rather unfavorably to the CAD$1.557 billion that it reported in the year-ago quarter.
  • Suncor achieved an average production of 762,300 barrels of oil equivalents per day during the period. This represents a 2.49% increase over the 743,800 barrels of oil equivalents per day that the company produced on average during the third quarter of last year.
  • The company reported total funds from operations of CAD$2.675 billion in the current quarter. This compares rather unfavorably to the CAD$3.139 billion that the company had in the year-ago quarter.
  • Suncor Energy reported a net income of CAD$1.035 billion in the third quarter of 2019. This represents a 42.88% decline over the CAD$1.812 billion that the company earned in the third quarter of 2018.

It seems likely that the first thing anyone reviewing these highlights is likely to notice is that essentially every measure of financial performance came in worse than what it had in the previous year. This was also something that we have at every other large oil company that has reported its results recently and is a product of the broader macroenvironment. As most readers likely know, the current market price for both oil and natural gas is significantly lower than it was a year ago. We can see this quite clearly here:

Source: Suncor Energy

As we can see here, Suncor Energy realized much lower prices for each barrel of oil that it sold during the most recent quarter than it did in the year-ago one. As Suncor Energy does not produce much in the way of natural gas, the fact that prices of this commodity are also broadly lower than in the year-ago one had relatively little impact. This is a relic of the market volatility that we saw in the fourth quarter of 2018 during which the price of essentially every market-traded asset went down. The stock market has completely recovered but oil and gas prices have not for a variety of reasons. One of these is that the market is widely perceived to be oversupplied with both oil and natural gas, particularly in North America, as producers in both the United States and Canada continue to grow their production and export capacity is not well-developed enough to absorb all of this supply. While we are seeing export capacity increase, I am skeptical that we will see energy prices return to anything close to their previous levels in the near future due to continuous supply growth.

It should be fairly obvious why lower energy prices would drag down an energy company's financial performance. After all, it is now bringing in less money for each unit of commodities that it sells, which translates into less overall revenues all else being equal. As revenues need to support all of the company's operations, this will normally translate to lower profits and cash flows unless the company slashes its expenses to adjust. A company in this industry can generally not cut expenses that quickly since most projects are on multi-year budgets and development timetables. Thus, the short-term profits of an energy company generally track energy prices.

Suncor Energy is generally considered to be an oil sands producer as approximately 88% of the company's output comes from the region. This is also the primary area of further growth as Suncor's enormous reserves easily support more development without the immediate need to discover new sources of resources. We actually saw this story play out somewhat in the quarter as the company's oil sands operations boosted their output to 670,000 boe/day compared to 651,700 boe/day in the year-ago quarter. The primary reason for this growth was the continued ramp-up of the Fort Hills project, which first started production in early 2018. This was something that we have long been discussing and this project has generally been having a positive impact on the company's oil sands production in every quarter since it began operating. Unfortunately, it also looks like this is going to be the last major oil sands growth project until oil prices are consistently higher and this does not appear to be likely in the near term.

One of the things that helped Suncor Energy weather the pricing environment last year, which saw West Canada Select oil trade at a very large discount to West Texas Intermediate (and much cheaper than it was in the third quarter 2019) is its refinery operation. The company owns four refineries throughout the United States and Canada that allows it to process about three-fourths of its oil sands production. This allows the company to sell the majority of its production at prices linked to Brent oil prices instead of the typically lower WCS or WTI prices. In some cases, this can also help the company partially offset the impact of lower oil prices because the crack spread (a measure of profitability for refineries) tends to increase when oil prices drop. This is because the price of refined products does not usually change as rapidly as crude oil does. Unfortunately, this unit of the company's operations also saw its financial performance decrease compared to the year-ago quarter. We can see this here:

Source: Suncor Energy

The unit did not see its processed volumes change by very much over the period so that cannot be responsible for the weakened performance that we see here. Rather, what we saw is that the price of gasoline did decline by more than oil prices did, which reduced the crack spread. This may actually be due to the narrowing differential between WCS and WTI prices. The refineries had an extraordinarily profitable last year because the difference between WCS and Brent was so wide. This year, the differential is closer to normal levels and so the firm's refineries have to settle for more normal margins.

In conclusion, we certainly see the impact of the broader macroenvironment here as the lower oil prices dragged on the company's results. Despite this, it does still continue to derive growth from the recent oil sands projects, although the company's forward growth prospects are nowhere near as strong as they were prior to 2014. As a result, I do think that there are better oil companies, with stronger growth prospects, to invest in. Suncor does remain a relatively stable way to play the sector, though.

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.