The recent record-setting initial public offering of Saudi Arabia’s state-owned oil company, known as Aramco (SAU:2222), has grabbed most of the financial news headlines of late. However, there is a Canadian enterprise, attractively priced, that operates, in terms of captive oil reserves, in a region that has been called the Saudi Arabia of North America.
Suncor Energy Inc. (NYSE:SU) is Canada’s largest integrated energy company. In terms of share price, it offers a far better value than shares of Aramco’s $1.5 trillion offering.
The company has many attractive qualities, including proven reserves with a long life, low production costs and an ample dividend. As a bonus, the company has a reputation for being shareholder-friendly. Translation? No exorbitant or profligate spending without regard to return on capital — a particular problem that has consistently plagued many shale oil production stocks.
Morgan Stanley energy analyst Benny Wong calls Suncor “a poster child for capital discipline and returning cash to shareholders.” Wong has an overweight rating on the stock and a price target of $38.
How does extracting oil from rich tar sand deposits differ from shale oil production? Suncor’s oil sands production is more similar to a manufacturing process than traditional oil production as the resources, close to the earth’s surface, are much more easily recoverable than shale oil and fracking production processes. For Suncor shareholders, this translates into a winning proposition: process the deposits, sell them and recover your cash.
Suncor’s stock has a dividend yield of 4% currently, and management intends to hike it roughly 10% every year going forward. An additional benefit for shareholders is that Suncor buys back a substantial chunk of its stock every year. How can the company finance such cash returns to its shareholders?
The answer is Suncor has tar sands which can produce for decades without hampering production volume. The company is generating substantial cash flow, even at current depressed oil price levels. It won’t need to invest much capital to maintain production at current levels.
Indeed, CEO Mark Little said at an industry conference in September that its “oil-sands exploration risk and costs are essentially zero.” Analysts figure that the company spends only 30% to 40% of its annual cash flow to sustain oil output — significantly less than expenditures incurred by old-line oil and gas companies.
The company’s break-even point? Suncor can spend enough to maintain output and sustain its dividend, even if oil prices drop to $45 a barrel. On Friday, West Texas Crude closed at $60.27 a barrel.
Should shale-producing companies experience a decline in production, oil prices should rise, giving Suncor even more robust operating margins. Another plus for the stock? the company’s all-oil-oriented operation is a bonus at a time when many U.S. rivals have exposure to the weak natural gas market.
Suncor also has a highly profitable refining business. Paul Sankey, an analyst with Mizuho Securities, calls it “the best in North America.” Last year, its enviable margins were more than double the average of its peers like Valero Energy (NYSE:VLO) and Phillips 66 (NYSE:PSX).
The biggest risks facing the company are a precipitous drop in oil prices, reduced refining margins and, given the dirty nature of the tar extraction process, the potential for increased and cumbersome environmental regulations.
U.S. shares of Suncor, trading around $31, now appear undervalued. They are selling at 14 times projected 2019 earnings of $2.42 a share, a discount to U.S. giants Chevron (NYSE:CVX) and Exxon Mobil (NYSE:XOM) and comparable with a smaller competitor, Canadian Natural Resources (NYSE:CNQ). As noted above, the company plans to hike the dividend every year as well as continue buying back its shares.
The stock has a dividend yield of 4% and closed Friday at $31.77. Its 52-week high is $34.87; its 52-week low is $25.81.
For those investors who believe that countries won’t be weaning themselves off of oil anytime soon, Suncor presents an appealing value play.
Disclosure: I have no position in any of the securities referenced in this article.
This article appeared in Gurufocus — a value investing site
About the author:
John Kinsellagh is a financial writer, former financial advisor and attorney, with over twenty-years experience in civil litigation and securities law. He completed the Boston Security Analysts Society course on Investment Analysis and Portfolio Management.
He has served as an arbitrator for FINRA for over 25 years resolving disputes within the financial services industry. He writes primarily on financial markets, legal and regulatory issues that impact the investment community, and personal finance.