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John Engle
John Engle
Articles (270) 

Berkshire Invests in Suncor: What Is Warren Buffett Thinking?

It could be a short-term play or a long-term bet on transformation

February 20, 2019 | About:

Warren Buffett (Trades, Portfolio) is not called the Oracle of Omaha for nothing. Many times throughout his long career, the boss of Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) has made stellar investments in companies the rest of the market was ignoring. Thus, when Berkshire takes a significant stake in a company, it tends to turn heads.

The latest Berkshire play to attract such market attention is Suncor Energy Inc. (NYSE:SU). The energy company has taken a beating in recent months. On Feb. 14, Berkshire disclosed a 0.7% stake.

Do Buffett and his team see a turnaround in the offing?

Second time’s the charm?

This is the second time Berkshire has held shares of Suncor. Buffett bought a stake in the Canadian oil and gas company in 2013, but sold out the whole position in 2016. Interestingly, it was not a particularly successful play, with Berkshire buying in shortly before the 2014 oil market crash sent energy stocks into freefall.

Suncor only really began recovering in 2017, meaning Berkshire missed the boat on their first attempt. Evidently, it thinks this time will be different.

Beaten down to bargain territory?

Things have not been going well for Suncor in recent months. Indeed, by December 2018, the stock had shed more than 35% from its summer high of $42.55 per share. It has since made some recovery, but was still down 17% from that 52-week high as of Berkshire’s disclosure. That implies considerable potential upside on the basis of technical analysis alone.

Suncor has traditionally traded higher, and its recent retreat can be blamed -- in part, at least -- on global oversupply issues. Perhaps that is what put it back on Buffett’s radar in the fourth quarter.

Short-term play?

Contrary to its reputation as a buy-and-hold investor, Berkshire has occasionally made short-term plays on stocks that have been beaten down by general market overreactions. It has even done so with energy stocks in the past, such as the last time oil prices crashed and sent stocks across the industry spiraling downward. A Berkshire portfolio manager dipped in and out of Kinder Morgan (NYSE:KMI), for example, taking full advantage of the pipeline company’s irrationally beaten-down share price in the wake of a surprise dividend cut.

Is this a similar situation? Or does Buffett see something more in Suncor than a quick flipping opportunity?

Betting on cost cuts?

A lot has changed at Suncor since Berkshire last sold out its position. Most importantly, the company has radically reduced the production costs associated with its oil sands and mining operations. It was once a high-cost producer, forced to shutter some operations when crude oil prices plummeted.

Based on its latest presentations, Suncor could probably keep going uninterrupted even with crude prices around $30 per barrel. It is not the cheapest producer by any means, but its transition is an ongoing process. Even so, it has already become a far more sustainable business, with the risk of global commodity price declines mitigated substantially.

Investing in transformation?

We can only guess at Buffett’s -- or his portfolio manager’s -- true intent when it comes to Suncor. But a position worth nearly $3.8 billion at the current share price is awfully big for a mere short-term flip trade. Based on what we know about Berkshire’s investing approach, this looks like a bigger investment in the success of Suncor’s quite radical transformation into a lower-cost producer.

Moreover, Suncor is blessed with both strong long-term reserves and production power. Its existing oil sands resources are expected to deplete at a rate of just 1% annually between 2019 and 2023. At 2017 production levels, its current resources should be good for about 36 years. That is a lot of long-term opportunity.

What are the risks?

We see the logic of a long-term investment in Suncor on the basis of its strong reserves and impressive cost reductions that have transformed it into a far more sustainable business. That said, the extraction and production business is cyclical and oil prices have been awfully confusing of late.

More importantly to Suncor’s situation in particular is its refining capacity. A deep look at the company’s financials reveal that the lion’s share of profits actually come from its refinery business. The margins are excellent, which is an attractive feature under most circumstances. However, as a commodity business, refinery margins rarely last. There may be some lag, but a key risk to Suncor is the expansion of refining capacity by others.

Verdict

Our interest has certainly been stimulated by Berkshire’s latest move. We see an attractive long-term value proposition in Suncor, thanks to its production cost reductions. But that will not be enough to make up for lost refining margins in the years ahead, unless it can continue to push down extraction costs.

Overall, we like Suncor, but we do not see an unassailable moat of the kind Buffett usually goes for.

Disclosure: No positions.

About the author:

John Engle
John Engle is president of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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