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Gordon Pape
Gordon Pape

Suncor Energy (NYSE: SU) Appears to offer excellent value

July 23, 2008 | About:

Suncor is an Oil Sands pioneer. The company traces its history back to 1967, a time when the Oil Sands were called the Athabasca Tar Sands and extracting crude from the land on a massive scale was an uneconomic pipe dream.

Today, Suncor has grown into a fully integrated oil company employing almost 6,500 people. It mines the Oil Sands using huge equipment, upgrades the tarry gunk at its giant Fort McMurray operation in northern Alberta , and refines the output in Sarnia , Ontario and Commerce City , Colorado .

The company also has a retail distribution network in eastern Canada under the Sunoco brand name (U.S. Sunoco stations are run by an unrelated company). As well, Suncor operates Phillips 66 stations in Colorado . In fact, the company supplies about 35% of Colorado 's gasoline and diesel fuel demand and is a major supplier of jet fuel to the Denver International Airport .

Suncor is not just about oil, however. The company is actively investing in clean, renewable energy sources including wind farms and ethanol plants.

Currently, Suncor has four wind power projects in operation with a total capacity of 147 megawatts. As well, the company has an ethanol production facility in Ontario and is planning to participate in a demonstration facility in Colorado to develop ethanol from non-food sources such as wood residues. Ethanol is blended into the Sunoco and Phillips 66-branded gasoline.

The security: We are recommending the purchase of the common shares of Suncor Energy which trade on both the New York and Toronto Stock Exchanges under the symbol SU.

Why we like it: Buying good companies cheap is every investor's goal. Right now, Suncor shares appear to offer excellent value. The stock is off 19% from its all-time high of $74.28, reached on May 21.

So why the big tumble when oil is trading near record highs? Part of the reason is due to a significant decline in production in June to an average of 144,000 bbl/d (barrels per day). That was almost 32% below the first half average daily production of 211,000 barrels.

The company said in a statement that the shortfall was due to "planned and unplanned maintenance during the month, including a complete shutdown of one of the company's two upgraders. The maintenance is now substantially complete and operations have ramped up to regular volumes". (Upgraders are the plants that convert the oil sands into synthetic crude and diesel fuel)

Suncor has stated in the past that its target is to average between 275,000 and 285,000 bbl/d in 2008. However, there was no mention of this target in the latest production statement, leading to speculation that the company will lower its guidance when it releases its second-quarter financial results on July 24. This in turn has put downward pressure on the stock.

The share price may also have come under pressure because of recent negative publicity regarding the environmental impact of Oil Sands production. The company has been a leader in reducing greenhouse gas emissions on a per unit basis but overall emissions have increased as more capacity has come on line.

In my view, this has resulted in an oversold situation, creating an entry opportunity. Suncor is already one of the largest operators in the Oil Sands, accounting for about 30% of the total upgraded production from the region. Earlier this year, the company's board of directors approved a $20.6 billion investment that is expected to boost crude oil production capacity from the Oil Sands by 200,000 bbl/d to 550,000 bbl/d in 2012. This ambitious expansion is Suncor's largest investment ever and includes four new stages of in-situ production and a new upgrader.

There are several methods of calculating the reserves of Oil Sands producers. According to Suncor's 2007 annual report, the company's proved plus probable reserves of synthetic crude range from a low of 2.3 billion barrels to a high of 5.1 billion barrels. Either way, there's a lot of oil there!

Financial highlights: Suncor's first-quarter financial results showed net earnings of $708 million ($1.53 per share), compared to $576 million ($1.25 per share) in the first quarter of 2007 (figures in Canadian dollars). Excluding unrealized foreign exchange impacts on the company's U.S. dollar denominated long-term debt and project start-up costs, first quarter 2008 net earnings were $788 million ($1.70 per share), compared to $567 million ($1.23 per share) last year. Cash flow from operations was $1.16 billion compared to $825 million a year ago.

Oil sands cash operating costs averaged $31.55 per barrel in the first quarter. Suncor's cash operating costs in 2007 were $27.80 per barrel and the company had said it hoped to come in slightly below that this year but the first-quarter numbers and the production drop-off in June probably make that impossible. However, the high price of crude has more than offset the unplanned increase in production expenses.

Although it will have to take on more debt to finance the next phase of its expansion, the company says it believes it "can maintain a strong debt to cash flow ratio at crude oil prices of US$60 WTI".

Risks: As we saw in June, any major unplanned work stoppage can have a significant impact on output and, therefore, on profits. However, such events are rare and short-term. Suncor has been in business for 40 years and the technology is proven; this is no start-up company.

The price of oil obviously has a direct impact on the company's profitability and its share price. Should oil drop significantly due to a global recession, Suncor's shares would feel the pain. Again, however, that would likely be a temporary phenomenon. Few people expect the price of crude to permanently settle back to below $100. A $200 price within the next couple of years seems far more likely.

Distribution policy: Suncor shares pay a small quarterly dividend of 5c on a March-June-September-December cycle. In view of the company's ambitious and expensive growth plans, dividend increases are unlikely in the near to mid-term future.

Tax information: The company says it has determined that it is a Qualified Foreign Corporation for U.S. tax purposes. That means its dividends qualify for reduced rates. The Canadian government imposes a 15% withholding tax on cross-border payments that may be recovered by claiming a foreign tax credit.

How to buy: The stock trades actively on the NYSE with several million shares changing hands daily. Enter an order near the bottom of the current bid-ask range. You should have no trouble getting a fill.

Summing up: After a recent meeting with Suncor executives at the Stampede Energy Conference in Calgary, the oil and gas analysis team at RBC Dominion Securities wrote: "At current levels we believe this represents a rare buying opportunity as generally the shares command a relative premium to its peers based on track record and experience". I couldn't agree more.

About the author:

Gordon Pape
Gordon Pape is the best-selling author/co-author of many acclaimed investment books, including the recently-published Sleep-Easy Investing (Viking Canada ). He is also publisher and editor of five investment newsletters, including the Internet Wealth Builder, Mutual Funds Update, The Income Investor, and The Canada Report, which was created specifically for U.S. residents interested in investing in Canada . He is a columnist for several magazines and websites and a frequently quoted media source. He has been a featured speaker at numerous events including the World Money Show in Orlando . His websites can be found at www.BuildingWealth.ca and www.TheCanadaReport.com.

Rating: 3.4/5 (8 votes)


Fireman - 9 years ago    Report SPAM
buy if oil future drops to 100; I preferred HSE than SU for long term (re: Toronto Stock Exchange).
Sabonis premium member - 9 years ago
This would have been a great call about 5 years ago. Getting in on the oil sands and SU right now might be a good call but its hardly an original pick. I love the company but I think the whole oil thing is a little "frothy" right now. I've been selling oil over the past 6 months.

I'd love to hear something new and original from the Guru Focus columnists. Whats next???? Give us some insight.

Any more advice? something we dont know?....what is your next column? something about a company in Redmond, WA that makes software? a good money manager in Omaha? ..dont put tin foil in the microwave...China is crowded because there are alot of people...whoever smelt it is often the one who dealt it...

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