Suncor Energy (SU, Financial) has already encountered a good amount of volatility in the trading sessions – the stock is down by more than 24% since the start of July 2014, after a good run in the preceding four months. The fall in the stock price is not due to any intrinsic issue with the company alone, but the whole sector has been badly battered due to the falling crude prices.
We believe the long-term growth potential of the company is good and the recent dip in price has made its price tag quite lucrative and presents an opportunity for the long-term shareholders to add to their positions. Let us take you through the details explaining our optimism about the company.
Suncor is engaged in exploration, development and production of conventional oil and natural gas as well. The company also has six operational wind power projects which are expected to do away with 500,000 tonnes of carbon dioxide per year. The St. Clair's biofuels plant is the largest in the country and contributes to reducing approximately 600,000 tonnes of carbon dioxide emissions annually. Furthermore, the company also has a strong foothold in the lubricants sector well supported by a well-knit retail network.
Integrated business model
Suncor Energy is the largest integrated energy company in Canada. It can boast of a solid asset portfolio in production, refining and retail. For any company in oil business, the main challenge is the sustainability and replacement of resources. With approximately 7.7 billion barrels of oil reserves and massive reliant resources of 23.5 billion barrels, Suncor can serve a fitting response to such a challenge. Considering these numbers, it is safe to assume that Suncor holds enough resources to reward its shareholders for quite a long term even if it scales up production with time.
Suncor runs four refineries – these refineries receive the lion's share of the company's production and have the capacity to process above 460,000 barrels of crude oil on a day-to-day basis. These refineries churn out diesel fuel, light oil, asphalt, gasoline as well as feedstock for lubricants. Suncor Energy also has an extensive retail network setup which consists of more than 1,500 Petro-Canada gas stations and wholesale outlets dotting across the American continent in particular and across the globe in general. The company produces a bouquet of more than 350 power and energy products and runs the show in 70 countries.
This integrated business model is also beneficial in times of reduced oil prices because then the increased earnings from refining and retail operations make up for the loss in revenue from oil production.
Business performance: Efficient operations and shareholders' returns
Suncor Energy uses ships, trains and pipelines to transport its products to the markets with highest revenue potential. Going by the second-quarter earnings report, Suncor was able to receive global-based pricing on almost all of its production. The company also stated that it transported a record 36,000 barrels of crude oil to its Montreal refinery by rail, per day. This also signals bright days for the investors as it means that an important development has been made by increasing the feedstock for refinery operations of the company which will get processed and hit the shelves generating income. Previously, the company was buying offshore oil for this refinery. But now Suncor is able to improve profit margins significantly by making low cost Western Canadian crude oil available to this plant. It plans to combine the Line 9 pipeline and rail shipments in the near future which mean that Suncor will be able to provide 100% of Montreal's feedstock requirements from Western Canada at a lower cost.
The same quarterly report also evidence that the company was able to cut down its capital spending for the year by $1 billion at a time when the oil market has developed considerable volatility and has unsettled heavily. This means that the company is prudent in managing its cash flows and adjusts spending accordingly. Suncor has also successfully lowered the production costs while optimizing its output. From a cost of $46.55 per barrel in the second quarter of 2013, the company brought the cost down to $34.10 per barrel in the second quarter of 2014.
Strength of its fundamentals
Suncor Energy has recently increased its dividend payout rate by 22% to $1.12 per share, while continuing the payout ratio of 33%. At the current stock price, the shareholders are receiving a 3% yield. However, the potential risks that might be culminating due to the southward movement of oil prices must not be ignored. If the global oil prices settle down below the $50 mark and if the new regulations of oil shipping by rail prevent Suncor from moving to higher-priced markets, then the company and its stakeholders might have to sail in the rough waters. If there is a potential delay in getting one of the three pipelines being built, that will make things murkier for the company.
The bigger picture, however, reveals that Suncor Energy is well positioned to deal with the short-term turbulence in the oil market. The shares of the company are trading at 14.5 times earnings and 1.4 times the book price. Therefore, long-term investors might consider it profitable to invest in the company's stock near current levels. When the world around it is crumbling, Suncor can still manage to hold its head high through the thick and thin that clearly indicates the solidarity of its fundamentals.
Considering an investment in Suncor Energy
There are two main reasons that make Suncor Energy an attractive investment proposition:
First, there is a high chance of increase in the demand of oil sands from Europe. Although sluggish demand from the European continent and the ongoing European financial crisis might be one of the major reasons for the slump in global energy prices, there is a high chance that Europe will look up to Canada to satiate its current demands. That is because of two main reasons: One, Europe has decided to abolish a rule that labels Canadian oil sands as dirty. And two, this move comes at a time when Russia is facing sanctions and hence Europe will be looking for new suppliers of oil. So this might be a chance for Canadian companies, and obviously the biggest company in the country to profit from this new opportunity would be Suncor.
Second, at a time when rising costs have negatively affected profitability, Suncor has successfully cut back on its expansion plans and operational costs and has diverted its attention toward achieving operational efficiency. The company is concentrating on smaller and incremental gains as of now. It is working toward growing current production by 100,000 barrels per day from existing capacity. This will not only reduce operational costs but will also increase the margins and enhance profitability to a great extent.
Conclusion
The oil prices around the world have been under pressure over the last few months –Â however, Suncor's strategy should allow it to weather this storm when its peers are succumbing to the pressure. The company's focus on optimizing operational efficiency and the management of CapEx shows that Suncor is proactive in tackling any crisis. On the other hand, the situation is becoming favorable for the company due to the Russian sanctions and favorable stance for its products from the European Union. We believe that these factors will bolster Suncor's revenues and earnings –Â all these factors make Suncor an attractive investment option and a strong buy recommendation at current levels.
