Thursday, August 1, 2013

Suncor Energy (SU) Earnings Update and Prelim Analysis

Suncor Energy is one of my personal stock holdings and I been following it for a long time. For those who are not familiar with Suncor, it is the largest energy company in Canada with market cap over $49 billion. The current company was formed when the legacy Suncor (mostly upstream oil sands) acquired Petro-Canada (upstream E&P and downstream) in 2009 in a $19 billion deal. As a result of the merger,  Suncor became an integrated energy company meaning it has upstream production operations (to extract oil) as well as downstream operations (refine crude oil into usable end-products like gasoline or other fuel). What I like about the integrated model is that it allows the oil company the option to maximize value by selling raw production directly from upstream operations if the market price of oil is high or by using upstream production as feedstock for its downstream operations, thus lowering costs and capturing additional margin by refining oil , when oil prices are low.

Q2 Earnings Highlights:

When I took first glance over the numbers, it look slightly negative because:

  • Operating EPS at $0.62 while analysts expected $0.63 
  • Total production was at 500,000 boe/d  vs. 513,000 boe/d expected 
  • The planned maintenance in its oil operations (lasting around 7-9 weeks) and the Alberta flood made operating results pretty ugly such as cash oil sand cost rose to over $45/bbl vs. $34 last quarter. 

Notes: boe/d = barrels of oil equivalent per day (natural gas out are converted at 6 mcf= 1 barrel )

Nonetheless, reading the full press release, I found several positive I think investor may like and they indeed did; the shares jumped  4% today.

  • The guidance for production is unchanged for 2013 despite lower first-half production numbers, this means management is expecting very strong numbers in second half this year after several major maintenance have been completed. With oil prices north of $100, timing is perfect to take advantage of the current environment. Note, given Suncor's costs are mostly fixed in nature, higher production will lower cost per barrel produced and the company will enjoy substantial operating leverage 
  • The major Fort Hills mining (oil sand) project is ready for sanctioning later year. This was one the major projects anticipated by investors which will have capacity to produce 180,000 bbl/d and expect first oil by 2016 
  • Capex was lowered from $7.3 billion for 2013 to $7.0 billion reflecting management's expectation lower cost (a recent project, Firebag 4, was almost 15% below budget cost) and delay of some less profitable projects 
  • Suncor is continuing its $2 billion normal course issuer bid or NCIB  (also know as share buyback program). After purchasing around $300 million shares at $31/share in Q2, Suncor revised its NCIB to have the option to buy up to $1.8 billion of stock in next 12 month starting now.  


The TRP Energy East Pipeline adds hope for additional de-bottlenecking of Alberta oil

TransCanada (TRP) also reported earnings today. What was interesting was the announcement the development of a pipeline to transport Alberta heavy crude to the east coast in New Brunswick where refineries are using higher priced Brent crude (Brent/WCS differential is still quite large despite WTI/Brent spread tightened to near 0 recently) imported from overseas and are operating at lower capacity. The pipeline will have a capacity of 1.1 million barrels per day (bbl/d) which is much higher than previous anticipated 800,000 bbl/d capacity.

For Suncor, this pipeline is positive but Suncor's CEO has stated its production growth (8% annual growth) can be maintain even without this Energy East pipeline or the Keystone XL pipeline which aims to transport 830,000 bbl/d down to the refineries down to the U.S. Gulf Coast.  Suncor will rise rail shipments of crude to 30,000 bbl/d, increase its current capacity on the Kinder Morgan's Trans-mountain pipeline which transport crude west to B.C, and receive cheaper feedstock for its Montreal refinery through the Enbridge's line 9 reversal project. I like the fact Suncor can pursue its growth strategy without dependent on uncertainty regarding pipeline developments like some other heavy producers.


Q2 Earnings does not change fundamental story behind my Suncor Investment


Despite a very depressed quarter in terms of production and costs, it still managed to generate operating earnings of nearly $1 billion.  Normal operating earnings at full capacity would probably reach $1.5 billion per quarter or a run-rate of $6 billion a year. Capitalizing earnings at a 10% (or in layman's terms, putting a 10X P/E ratio on), would give a value ~$60 billion or ~$40/share vs. current $33.50. A 10X multiples almost very conservative already given it has traded multiples near 15X before but I'll rather stick with a conservative valuation.

On a cash flow basis, the depressed Q2 still brought $2.5 billion in operating cash flow. Normalized cash flow could reach at least $3 billion per quarter or $12 billion a year. I'll stick with this more conservative assumption but I have no doubt it will be higher. Management expects capex remain fairly steady going forward at $7 billion. This gives a free cash flow of $5 billion for a typical future year. Even growing cash flow by a 2% inflation, a free cash flow valuation would give $37.75-$43.90  using 9%-10% cost of capital (often called WACC)

So some basic valuation gives me a valuation of ~$40/share (mid-point of $37.75 and $43.90 is $40.80). Some may criticize my analysis is too simple, but sometime simpler may be better. The normal earnings and cash flow numbers are estimated using rough calculation to assume full capacity at >600,000 bbl/d production vs. 500,000 bbl/d in Q2 and reflect a change in higher oil prices. My assumptions are still very conservative and give me a margin of safety given I use a  low multiple for earnings and discounted cash flow at merely assuming growth is only inflation (no real growth).

Will provide more thoughts on Suncor after I look through its full Q2 report. This commentary is provided after I read the press release and listened to its conference call.

UPDATE: Berkshire Hathaway in Q2 disclosed a new 17.8 million share position in Suncor valued at $500 million. I believe Buffett and his two money managers are seeing good value in Suncor and I do too! 

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