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Behind Warren Buffett’s Oil & Gas Canadian Pick

April 10, 2014 | About:

What picks a guru from a determinate industry and geography can be hard or impossible to infer. For that reason, looking at the economic conditions surrounding the moment of the purchase, can be a whole lot more useful when looking for an investment. If there is one thing about Mr. Buffett and investing is the will to take some risk. In other words, he would prefer to buy an underperforming stock and hold on to it for some time. This is not to say that an investment by Berkshire Hathaway will only go on under those circumstances. Here it is only highlighted the fund is more likely to invest under those circumstances. And Suncor Energy (SU) may just be one example. To start presenting the case, it is worth noting the timing coincided with low Peter Lynch earnings.

A Favorable Market Environment?

When Mr. Buffett bought stock from Suncor Energy back in mid-2013, four out of six financial institutions were giving the stock a “Buy” rating. Moreover, the remaining two institutions reiterated a “Hold” rating, while simultaneously raise target price. Also, the stock purchase occurred at the lowest of the Peter Lynch earnings curve since October, 2010. Stock face value had also been on a decline since the end of January. Hence, the stock’s prospects do not seem to have been a secret to no one, and an important liability to most.

Since the purchase of Suncor Energy by Berkshire Hathaway shares are up 17%, and the 5 million shares sold during the last quarter of 2013 returned a 20% profit. Most importantly, the institution still owes 1% of the company that accounts for 6.8 percent of the country's gross domestic product and employs more than 280,000 Canadians. Most importantly, Suncor Energy enjoys of wide access to the US market, where consumption is expected to rise by 56 percent between now and 2040, according to the U.S. Energy Information Administration.

Most recently, Suncor Energy announced the overhauling of its Edmonton refinery. The projects expects to carry out maintenance over the 64 years old asset that processes 142,000 barrels of oils sands daily. Regardless of the slowdown, financial institution TheStreet upgraded the stock’s rating to “Buy” last Friday.

Strength and Prospects

Financially, Suncor Energy holds a solid business model, amid a slowdown in revenue and net income growth. Cash flow has been augmented while debt level decreased, and operating margin remained on the high teens during the last three years. Another note of color is a strong reserve of available free cash, part of which was used for share value creating policies, allowing for net earnings to recover most of the lost ground during 2012.

The upside to a long-investment on Suncor Energy is significant oil sands and conventional production platforms, huge long-lived oil-sands reserves and an impressive downstream portfolio. Specifically, the company has reached a dominant position in the oil sands business with as much as 23.5 billion barrels in reserves. These Canadian reserves located in Alberta hold a longer production life than shale reserves located in the US, reason for which a higher demand for Suncor Energy’s products is expected.

Last, Suncor Energy began to implement a 10 year long production plan, with the object of reaching the 1 million barrels of oil equivalent per day mark. And like other oil producers and explorers, result heavily depend upon oil and gas prices. Most importantly, currently the stock is trading at 15.3 times its trailing earnings, carrying a 28% premium to the industry average. Hence, although Peter Lynch would recommend buying the stock, it is a little overpriced but worth the effort if thinking about a long-term investment.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.

About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website


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