Dividend Growth And Buybacks – Why Suncor Remains One Of My Best Ideas In Energy
by Leo Nelissen Contributor since 2015 / 32053 Followers
4 months ago
Summary:
Canada’s role in the global energy sector is essential due to its large reserves and low decline rates.
Suncor Energy is a standout company in the sector with efficient operations, deep reserves, and impressive production growth.
Shareholders can expect strong cash flow, rising dividends, and aggressive buybacks as debt levels decrease, making Suncor an attractive investment opportunity.
XtockImages
All financial numbers in this article are in Canadian dollars unless noted otherwise. Oil and gas prices are always in US$.
Introduction
On May 12, I wrote an article titled “Cash Flow Gusher: How Cenovus Energy Can Shower You With Dividends.”
In that article, I discussed the increasing importance of Canadian oil and Cenovus Energy’s (CVE) role in this.
Essentially, there are two reasons why Canada’s role in the global energy sector is essential:
Canada has a lot of reserves. In fact, as reported by the aforementioned Reuters article, it holds the world’s third-largest bitumen reserves. This means producers do not need to be afraid to run out of high-quality reserves anytime soon. Most major Canadian producers have proven reserves for up to forty years.
Statista
These assets have extremely low decline rates. While elevated upfront costs may occur, production rates are very reliable and often cheap.
Supported by new pipeline takeaway capacity (i.e., through the Trans Mountain Pipeline) and higher global oil prices, Canadian players are in an increasingly good spot to serve rising demand and reward shareholders.
“The extended period of comparatively higher oil prices has strengthened producer balance sheets and has begun to open the door to some more ambitious projects, still primarily leveraging existing infrastructure,” analysts Kevin Birn and Celina Hwang said in a blog post about the report. Several projects are set to grow 20,000 to 50,000 barrels a day “through optimizations, efficiency gains or commercialization of small-scale assets.” – Bloomberg
One of my favorite companies in this sector is Suncor Energy (NYSE:SU). My most recent article was written roughly three months ago, when I wrote the following:
In this sector, Suncor Energy stands out as a prime example, with its robust operations and commitment to shareholder value.
Despite its impressive fundamentals and potential for significant upside, SU remains undervalued, trading at a mere fraction of what I believe to be its fair price.
With favorable industry dynamics and upcoming catalysts like the Trans Mountain Pipeline expansion, SU emerges as a compelling investment opportunity.
Since then, New York-listed shares have returned 20%, beating the 4% return of the S&P 500 by a wide margin.
After a sideways movement that took almost two decades, Suncor Energy is gaining momentum, which I expect to last.
In this article, I’ll update my thesis with the help of its latest earnings and explain why I believe Suncor remains one of the cheapest high-quality opportunities in its sector.
Efficient Operations, Deep Reserves, And Output Growth.
Like its much bigger peer Exxon Mobil (XOM), Suncor is a major-integrated oil stock, as it produces oil and gas (upstream) and turns this into value-added products (downstream/refining).
In its recently released first quarter, the company achieved a record refining throughput of 455,000 barrels per day, which marks a 24% increase from the prior year quarter.
This record was driven by an impressive utilization rate of 98% (the best first quarter ever!), with the company’s Edmonton facility exceeding 100%.
Suncor Energy
Additionally, product sales reached an all-time high of 581,000 barrels per day.
Meanwhile, in the upstream segment, production also hit a record high of 835,000 barrels per day. This translates to a 13% increase.
Especially, the integration of In Situ operations with large upgraders has provided the company with significant flexibility and value maximization, proven by an upgrader utilization rate of 102%.
Speaking of In Situ operations, this is a major part of the company’s operations. Like its Canadian peers, the company benefits from its operations in Canada’s oil sands. These operations have low decline rates, which means they are relatively more attractive than U.S. shale operations, which require new capital to maintain production rates.
The chart below shows the steep decline rates in the Permian Basin and the fact that decline rates are worsening, which is a sign that producers are running out of Tier 1 production inventories. This is highly beneficial for Canadian players, as I believe we will see increases in breakeven rates for most U.S. producers.
Enverus & Labyrinth Consulting Services, Inc.
Although Canadian oil sands require higher upfront capital, they have highly favorable decline rates. Suncor Energy’s corporate decline rate is just 5%.
Unfortunately, Canadian oil sands have a much worse carbon footprint.
However, I do not believe that this is an issue. While it’s far from perfect, Canadian operations are too critical to be impacted by these environmental headwinds – as heartless as that may sound.
Suncor Energy
It also helps that the company has massive reserves, with its oil sand operations sitting on 26 years of reserve life, which is consistently being expanded through new discoveries.
With regard to operating efficiencies, and going back to its first quarter, the company’s total operating, selling, and general costs remained flat at $3.4 billion – despite the aforementioned increases in production and refined volumes.
That’s a fantastic result!
According to the company, operational leverage allowed it to achieve lower unit costs across all major assets compared to the first quarter of 2023.
This includes investments in new technologies, including autonomous haul trucks. Going forward, Suncor expects significant cost benefits by boosting the number of autonomous trucks to 91 by the end of this year.
Moreover, the company is replacing older third-party trucks with new 400-ton trucks.
To add some color, Suncor expects these measures to lower overall corporate breakeven costs by roughly $1 per barrel, which is a big deal.
In general, Suncor has very low breakeven prices, with operating costs of its upstream operations not exceeding $38 per barrel. That’s in the high-US$20s range.
Great News For Shareholders
Great production numbers came with great news for shareholders.
In the first quarter, the company generated $3.2 billion in adjusted funds from operations. It returned $1 billion to shareholders. $700 million of this consisted of direct distributions (dividends). $300 million was returned indirectly through buybacks.
SU currently pays $0.545 per share per quarter. This translates to a yield of 4.0%. Its most recent hike was 4.8% on November 15, 2023, slightly below its five-year CAGR of 7.3%. The only difference between the two lines below is the CAD/USD exchange rate, as New York-listed shares are subject to currency fluctuations.
The good news is that buybacks are likely to accelerate soon.
In the first quarter, the company reduced net debt by $200 million to $13.5 billion.
At these debt levels, the company spends as much on buybacks as it spends on debt reduction (both enhance shareholder value). Once it hits $9 billion in net debt, it will stop reducing net debt and return all excess free cash flow to shareholders through buybacks.
Suncor Energy
Analysts expect net debt to fall to $8.6 billion this year. While that’s a theoretical number subject to change, it implies SU could start returning cash more aggressively in the second half of this year – especially going into 2025.
Moreover, as analysts expect the company to generate $7 billion in free cash flow this year (based on current conditions), it could return roughly 10% of its current market cap to shareholders.
Valuation
So far, I’m very impressed with Suncor.
Production growth is impressive and supported by new takeaway capacity.
It has deep reserves and low breakeven prices.
Operating expenses remain subdued, even in light of higher output.
While buybacks have been a bit lower than the company expected, it is quickly moving to a situation of more aggressive distributions.
It is also attractively valued.
As Suncor continues to improve its business, I believe it is one of the cheapest stocks in its sector.
Using the FactSet data in the chart below, the company trades at a blended P/OCF (operating cash flow) ratio of just 5.7x. I believe it should not trade below 8.5x OCF, which is a valuation common among U.S. shale players.
As analysts expect $10.57 in 2026 per-share OCF, we get a fair price target of $90, which is 63% above the current price. The same also applies to New York-listed shares (with currency risks).
FAST Graphs
In my prior article, I went with a $120 price target. However, back then, I used a 10.2x multiple.
While I believe a double-digit OCF multiple will be applied when the market rotates from growth to value stocks, I believe an 8.5x multiple presents the current environment a bit better.
Hence, I continue to give the stock a Strong Buy rating. If I did not have so much energy exposure already, I would be a buyer, as I think it’s very hard to beat the value Suncor brings to the table.
Takeaway
Suncor Energy’s compelling investment case is hard to ignore.
With its deep reserves, low decline rates, and impressive production growth, Suncor stands out in the energy sector.
The company’s efficient operations and significant reserves ensure long-term stability, while new projects and high utilization rates drive growth.
Meanwhile, shareholders are set to benefit from strong cash flow, rising dividends, and aggressive buybacks as debt levels decrease.
Despite its solid fundamentals, Suncor remains undervalued, offering a prime opportunity for substantial gains.
Hence, I maintain my Strong Buy rating, projecting a fair price target of $90, which represents a 63% upside.
Pros & Cons
Pros:
Deep Reserves: Suncor sits on extensive reserves with a 26-year lifespan, ensuring long-term production stability.
Low Decline Rates: Unlike U.S. shale, Suncor’s low decline rates translate to lower maintenance capital and consistent output.
Operational Efficiency: Achieving record refining throughput, high utilization rates, and upstream growth while maintaining subdued operating costs is a big benefit.
Shareholder Returns: With a robust dividend yield and (potentially) aggressive buybacks, shareholders are set to benefit from strong cash flows.
Attractive Valuation: Trading at a subdued P/OCF ratio, I believe Suncor is undervalued, presenting significant upside potential.
Debt Levels: Although decreasing, current debt levels could limit financial flexibility – especially if the company’s debt declines less rapidly than expected.
Commodity Price Volatility: Suncor’s performance is heavily tied to oil price fluctuations, adding commodity price and cyclical risks.
Analyst’s Disclosure:I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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