Stock’s Details 

Integrated business model and strong cash flow generating capabilities make Suncor an attractive bet: Headquartered in Calgary, Suncor (TO: SU) is Canada’s leading integrated energy company. From digging oil to refining and selling it, Suncor Energy is involved in the entire value chain. The company is focused on developing Canada’s Athabasca oil sands basin, which is one of the largest in the world. Suncor operates through three reportable segments including, Oil Sands, Exploration and Production (E&P), and Refining and Marketing. In 2019, Suncor posted funds from operations of CAD 10.82 billion, compared to CAD 10.17 billion in 2018.

Investment case

Being one of the largest integrated oil company, Suncor Energy benefits from controlling the entire value chain. The company’s business model acts as a hedge during tumultuous times and allows it to outperform peers. Besides, the company generates strong cash flows allowing it to boost shareholders’ return through dividends and buybacks.

• Integrated business model provides competitive advantage: Suncor’s integrated business model acts as a cushion in variety of adverse market conditions. Despite the government of Alberta’s imposition of mandatory production curtailments, Suncor manages to leverage its Oil Sands production by integrating it with its midstream and refining assets. While the industry is struggling amid pipeline capacity constraint, Suncor’s secured committed pipeline capacity, along with its additional rail capacity helps the company in getting the products to the markets to capture global pricing, thus maximizing the value of the barrels it produces. The company’s focus on optimizing the product mix and integrating its assets could continue to offset the impacts of the mandatory production curtailment and derive maximum value.

• Suncor Energy is a cash cow: Suncor is a shareholder friendly company, which implies that it continues to boost shareholders’ return through increased dividends and share buybacks. In 2019, the company returned CAD 4.9 billion to its shareholders in the form of dividends and share repurchases. The company distributed CAD 2.61 billion in dividends and repurchased CAD2.27 billion worth of shares in 2019. Since 2017, the company paid CAD 7.1 billion in dividends and repurchased CAD 6.7 billion worth of shares, implying over 9% of its outstanding common share. Given the company’s strong financial position and ability to generate significant amount of cash flows, we expect Suncor to continue to enhance shareholders’ return in the coming years. The company aims to increase its free funds flow by CAD 2 billion annually by 2023, which is likely to provide solid foundation to increase shareholders’ return.

• Oil Sands to sustain momentum: Management expects Oil Sands operations production to increase in 2020, which is a positive. Management expects Oil Sands operations production to increase from 412.8 mbbls/d to 420.0– 455.0 mbbls/d in 2020. Increase in production coupled with higher price realization is likely to boost the funds from operations.

• E&P segment poised well for future growth: The ramp up in the Hebron production volumes coupled with the company’s continued investments in the near-field developments of the existing assets is likely drive E&P segment’s future growth. The offshore assets not only help in diversifying its portfolio, but also attracts global-based pricing. Notably, White Rose asset returned to full operations, while it completed the planned maintenance at Terra Nova, which is expected to extend the life of Terra Nova asset and add additional production volumes.

• Downstream business looks rock solid: Suncor’s continued operational excellence and higher utilization rates makes its downstream operations rock solid. In 2020, we expect both crude throughput and refined product sales to increase, thus driving the overall efficiency and profitability.

Operation Details:

The Oil Sands business remains critical to Suncor’s success as the segment generates major chunk of its cash.  Suncor’s Oil Sands segment digs out bitumen from the mining and in situ operations. Then this bitumen is either upgraded to synthetic crude oil or SCO for refinery feedstock and diesel fuel, or it is blended with diluent for direct sale to the market using its midstream infrastructure and marketing. In 2019, SCO production reached 485,600 bbls/d, which is a record high. Moreover, it reported funds from operation of CAD 6.06 billion in 2019.  

Suncor’s Exploration and Production (E&P) segment has offshore operations. E&P segment’s funds from operations came in at CAD 2.14 billion. Refining and Mining segment has two operations. Suncor refines crude oil into a wide variety of petroleum and petrochemical products. Meanwhile, it sells the refined petroleum products to under the company owned banner of Petro-Canada and Sunoco. The segment reported funds from operations of CAD 3.86 billion.

Suncor’s Funds from Operations (Source: Company Reports)

4QFY19 Financial Highlights:

In 4QFY19, the company’s funds from operations totaled to CAD 2.55 billion (or CAD 1.66 per common share), compared to CAD 2.01 billion (CAD 1.26 per common share) in the prior year period. Notably, fourth quarter marked the tenth straight quarter where funds from operations came in above CAD 2.00 billion, which is an encouraging sign. Suncor’s 4Q19 operating earnings came in at CAD 782 million (CAD 0.51 per common share), compared to CAD 580 million (CAD 0.36 per common share) in the prior year period. The year-over-year growth was due to the improved western Canadian crude oil differentials partially offset by lower benchmark pricing. Operating earnings took a hit from lower Oil Sands production. However, improved western Canadian crude oil differentials led to an increase in Oil Sands price realizations. Suncor reported net loss was CAD 2.33 billion (CAD 1.52 per common share) in 4Q19 compared to a net loss of CAD 280 million (CAD 0.18 per common share) in the prior year period. However, 4Q19 results were negatively impacted by a CAD 3.35 billion of non-cash after-tax asset impairment charges.

Production volume details: The company’s total upstream production came in at 778,200 boe/d in 4Q19, as compared to 831,000 boe/d in the prior year period. The decline primarily reflected lower production in the Oil Sands segment due to the mandatory production curtailments and planned maintenance.  However, E&P production volumes rose year-over-year, reflecting increased production from East Coast Canada and Oda. Oil Sands production came in at 418,100 bbls/d, as compared to 432,700 bbls/d in the comparable prior year period. Production volumes at its E&P segment rose to 115,900 boe/d in 4Q19 compared 90,200 boe/d in the prior year quarter. Suncor announced Refinery crude throughput of 447,500 bbls/d and refinery utilization rate of 97%.

Cash Flow and Balance Sheet: During the quarter, the company generated cash flow from operating activities of CAD 2.30 billion, as compared to CAD 3.04 billion reported in the year-ago period. Suncor paid CAD 644 million in dividends and repurchased CAD 452 million worth of shares in the fourth quarter. Suncor raised its quarterly dividend by 11% to CAD 0.465 per share. At the end of the quarter, the company had cash and cash equivalents of CAD 1.96 billion. Total debt stood at CAD 17.97 billion, indicating a debt-to-capital ratio of 29.9%.

Financial Highlights (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 26.1% of the total shareholding. Wellington Management Company is the entity holding maximum shares in the company at 4.94%. The Vanguard Group is the second-largest shareholder, with a holding of 3.12%.

Top Ten Shareholders (Source: Thomson Reuters)

Key Metrics (Source: Thomson Reuters)

Key Valuation Metrics (Source: Thomson Reuters)

Valuation Methodology:  

Method 1: P/CF Multiple Approach

Price to Cash Flow Valuation (Source: Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Method 2: EV/EBITDA Multiple Approach 

EV/EBITDA Valuation (Source: Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: As on 2 March 2020, the stock had a market cap of ~CAD 55.98 billion with a P/E multiple of ~20.3x and an annual dividend yield of ~5.05%. We have valued the stock using two relative valuation methods, i.e., P/CF multiple and EV/EBITDA multiple, and for the said purpose, we have considered peers like Imperial Oil Ltd (TO: IMO) and Cenovus Energy Inc (TO: CVE). As discussed above, Suncor Energy’s competitive advantage enables it to command a premium over its peers. Further, the company’s ability to generate strong free funds flow and expected increase in production volume bode well for growth. Notably, the stock has corrected by about 12% since the start of the year and offers a lucrative dividend yield of about 5.1%, which makes it an attractive investment option. We have arrived at a target price with an upside in lower double-digit (in percentage terms). Considering the above factors, we give a “Buy” recommendation on the stock at the current market price of CAD 36.80 per share, down ~0.5% on 2 March 2020.

1-Year daily price chart (as on 2 March 2020). Source: Thomson Reuters.

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