$SU - Suncor Energy - Canadian oil sands stock to invest in

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Avatar for JohnyTempus
2 years ago
Topics: Investing, Stocks

Hello, as a start, I will recomnend you to check my prior articles and possibly check the outcome up to date their outcome (in short I wrote about $MAC and $AMS.ZU).

This is an article with another non-crypto investment idea to diversify your portfolio. I truly believe that you should not allocate 100% of your portfolio to only 1 asset class, hence I write here mostly about stocks.

First, I will start by saying that this is another "return to normality" stock, meaning that I expect its share price as a minimum to return to the pre-pandemic levels:

i.e. I would expect a price of a minimum of 45with the current being 28, so around 60% return within a year or two. But there is more to it - on top you will receive nice dividends for waiting + potential for th

e price to get even higher.

As you got from the name of the topic, the company is an integrated oil company, i.e. it drills oil, sells it, refines it, and sells also petroleum products. Thus the revenues and income of company are highly correlated to oil prices. This is the crude oil price chart:

As you can see, the crude oil is already on pre-pandemic levels, but the company price is still waaay down with a 60% increase expected.

As always at first we will talk on why it is like that, the market can not be that stupid to not see these 2 charts. Well, there are the below reasons/risks that I think affect the stock price:

1) The general stupid push for more "green" investments. The big funds, big new investment vehicle, big pension funds - basically all the "whales" that often move the stock significantly are currently not investing in oil companies, as those are not environmentally friendly. Some of these funds are often just not allowed to invest anything into oil and gas sector. If this adds you more comfort - Warren buffet held this company, but had to sell due to environmental and green preassues on the stock of Berkshire Hattaway.

SU is specifically involved in extracting oil from canadian oil sands that is considered especially " dirty". Canadian Oil Sands - Oil Sands

If you are an investor that does not care too much about it - you can use this limitations of big funds to buy a good profit making stock for a cheaper price. Now, not that I do not care about the environment, but my idea is that it is not the big oil company that pollutes the environment. So for me personally investing in oil and gas companies is not an issue.

If you will ask me - why will I expect those big funds to come back, so that the stock price flies again? My reply would be - they are not needed. You will read below that the company will use its cash to buy back its own stock, so the comapny will basically just decrease the amount of shares on the market. Plus after a certain point of time when company just becomes very attractive (dividend wise or just earning wise) there will be people who will be buying the stock of this comapny.

2) The general idea that oil is dead. Western countries imagine that we will switch fully to renewables, electrify everything (cars, planes, etc) and this will happen in next 5 years. Hence oil companies will become loss making.

I am not expecting this to happen, specifically this is not happening at all in the developing countries. Yes, "western world" becomes less reliant on oil and gas (mostly duue to governments subsidising green energy, electric cars etc.) But thi does not happen yet in emerging countries, as there is less money there and those are used for different needs. Most of the growth (including population) comes from emerging countries, so oil and gas business will continue to grow for next 5 years as a minimum. This is an enough timeframe for this investment. This point could actually be a long debate and a topic for a separate post, but here is the chart of expected oil demand in the coming years.

It shows that the oil demand could peak in 2025 and then veeery slowly decline (if tech acceleration/tech development is super strong). If not - we continue growth.

3) There is a thesis, that we have enough oil. Even if demand goes up - there is so much supply that the prices of oil will not stay elevated.

Indeed this is a risk, but I doubt this will happen in the comming few years. And there are 2 main reasons for this. First, is the point 1) above. Oil and gas are now considerred to be a " dirty" business. Who will want to get into canadian oil sands? who will want to finance the project there? Banks will not lend money to companies currently to get into dirty canadian sands as this will affect their ESG rating -> less investments -> stock price of the bank will fall. Check the main oil majors (BP, Shell, even Exxon) - they all do not invest in oil anymore, most of their investments are into renewables. The demand is growing, but there is lack of invesments to the supply side. Second point is that oil prices fell significantly prior to Coronavirus pandemic was the boom in the US shale production. It was a new technoology that allowed to extract a lot of additional oil. This increased supply significantly, hence crude oil prices went down. Cost of shale oil was quite high, so most of those companies were profitable only with high oil prices. Well guess what - most of those companies got broke and closed down during last few years due to the low oil prices. It is not a matter of a button to push to restore that. Everything has to be built from the beginning. This needs money and who will give them? Again, who will give money to a dirty business that just recently went broke? no one. Shale business is not coming back. It might come back after few years of elevated oil prices. And het, once you hear that the shale oil business is booming again - you sell this oil stock. At that point of time, oil will be considered as a great investment and that is the time when you exit this cyclical business.

4) Last point why the stock price is still down are the folks who invest in stocks due to dividends. When pandemic started Suncore cut its dividends by more than 50% to preserve cash. Obviously this affected the stock price and despite the good Q1 2021 results the company did not reinstate the dividends, hence those people interested in dividends did not get back yet. Why the dividends are not yet back is discussed below in the bull points of the company.

Bull case:

Now let's talk about the bull points of Suncore, that as you will see are also the points that currently keep the stock price down:

1) Same as point 1 above: Suncore is considered a dirty business - hence we do not expect any big new competitors coming into space. Moreover there is a risk that use of new oil fields in this area will be banned. The bank though will not be applier retroactive, so all the fields that are used currently by Suncore will still be available for SU to use. SU has one of the biggest reserves in Canada.

2) Financial results already now in Q1 2021:

In Q1 2021 (where oil price was lower than in Q2 2021 (check the chart above) the company made 0,54 dollars of income, or 2.16 annualised. i.e. in 10 years the company would earn everything it is worth currently. Those are great results. Co,apny a that time announced that their new cost of a barrel of oil (with all the corporate expenses included) is 35 USD. So with oil above 35 USD the company is just printing money.

3) How money is used. I just LOVE how the company uses the cash that it is currently printing. They did not restore the dividends, but rather decided to pay off debt and do the buy backs of shares. The dividends will be reinstated later. Here is the small chart of the return to shareholders that is planned by Suncore in the next 5 years if the oil is 55! USD. Now it is 66.

so in 5 years 6$ per share will be used to pay down debt, that will as a result decrease the interest expense of the company and hence again increase the profitability.

7$ will be used for buybacks. They plan on buying back roughly $10B in shares. Market cap is currently $35B. So they will buy around 1/3 of their shares back. This means that your shareholding will increase by roughly 30%. That is partially why the stock price will increase.

8$ per share of dividends over 5 years would normally be around 1.6 per year. But company will cut the number of shares by 1/3 through buybacks. Here we come back to a point 4 of why the stock price is not up yet. Yes the comapny did not reinstate dividends, but at first it will buy back shares - decrease the amount of shares, so than when dividends are paid they need to be paid for less shares. Hence dividends are either more sustainable or can be higher. Assume they wil be just higher. In a proposed scenario, you will actually receive 8*4/3=10.7 per share, or around 2.13 per year. Let's round it down to 2 $ per share per year - meaning a dividend yield for the current cost of the company of 2/28= 7%. You will not find those % in USD easily.

And that’s at $55 WTI.... sensitivity analysis implies an incremental $2.4B annual incremental FFO at $65 WTI... if directed towards buybacks, that’s another 7% of outstanding shares bought and cancelled.

As a conclusion, I do think that this company is a money machine that can be bought cheap just because it is out of favour as it is not green and dirty. Imagine with a price of 27m company is planning to return to shareholders 21 within 5 years and this is with the expenses to maintain business on the same level going forward.

I would have a price target of around 40 in 2 years time, with a dividend yield if you but it now at around 7%. Once we hit 40 - you might evaluate whether you want to actually sell it, or hold it because of the fat dividends you will receive.

For the very end - you might say that similar thesis can be applied for almost any oil and gas company and why I chose specifically Suncore:

1) Company recoverred less than its peers due to being specifically dirty (and I like this) and the company did not bring its dividends back yet, as concentrated more on buybacks (and I explained why I like it as well)

2) On the last investors presentation the CEO stated the following: "We will not sell assets to achieve our emissions reduction targets. Emissions are global and the world will only get to net zero by focusing on emissions reductions, not by changing who’s reporting them.” - this is exactly what I want to hear from an oil and gas comapny. I do not want an oil company to sell its assets as Shell does to meet CO2 goals or to invest some ridicilous money into renewables that bring much less money like BP does.

3) Oil sands have low decline rates, low break even, canada has low taxes, lower regulation. Why would anyone invest in US or any other big regulated international oil comapany vs Canadian oil producer.

P.S. Hey, when WTI was at 66 USD last time the price of Suncore was 45$. Waiting for the market to realize...

I was trying to find a picture of "oil" for the article and I either receive paintings or pictures where oil is spilled somewhere in the see or on the grass (suggesting how environmentally bad it is). Tells you all on how oil is percieved now and why it is a great investment.

I own the stock bought at 16.78 and part at 22.67. You can see that my cost basis is already much better than the current price, but I do not think you are late on this trade.

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Avatar for JohnyTempus
2 years ago
Topics: Investing, Stocks

Comments

Be mindful of the incoming market correction though.

$ 0.00
2 years ago

Great post, natural resources is a good backbone in Canadian Investing. RHC is a great pick too; US is in high demand for Helium and RHC has tons of rich wells.

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2 years ago