Suncor Energy
/ (SU-NYSE)/ Equity Research / SU | Page 1
Current Recommendation / UNDERPERFORM
Prior Recommendation / Neutral
Date of Last Change / 12/19/2014
Current Price (12/18/14) / $31.14
Target Price / $28.00
SUMMARY
Amid a weak crude pricing environment, we are recalibrating our investment thesis on Suncor Energy to Underperform from Neutral. The plunging crude price since Jul 2014 has been affecting the company’s upstream operations. On top of that, we don’t see any immediate spike in crude prices with plentiful supplies in the face of lackluster demand. Post Petro-Canada acquisition, we are also worried about Suncor’s elevated debt level and significant anticipated capital expenditure requirements. Moreover, the operational and project execution risks will keep the stock under pressure in the coming months. Owing to these factors, we see the company as a risky bet that investors should exit./ Equity Research / SU | Page 1
SUMMARY DATA
52-Week High / $43.1752-Week Low / $26.90
One-Year Return (%) / -5.64
Beta / 1.66
Average Daily Volume (sh) / 5,826,870
Shares Outstanding (mil) / 1,451
Market Capitalization ($mil) / $45,196
Short Interest Ratio (days) / 1.57
Institutional Ownership (%) / 59
Insider Ownership (%) / 1
Annual Cash Dividend / $0.98
Dividend Yield (%) / 3.15
5-Yr. Historical Growth Rates
Sales (%) / 6.6
Earnings Per Share (%) / 33.2
Dividend (%) / 23.0
P/E using TTM EPS / 9.5
P/E using 2014 Estimate / 10.1
P/E using 2015 Estimate / 10.6
Zacks Rank *: Short Term
1 – 3 months outlook / 3 - Hold
* Definition / Disclosure on last page
Risk Level * / Above Avg.,
Type of Stock / Large-Value
Industry / Oil-C$ Integrtd
Zacks Industry Rank * / 239 out of 267
OVERVIEW
Calgary, Alberta-based Suncor Energy, Inc. (SU) is Canada’s premier integrated energy company. Suncor's operations include oil sands development and upgrading, conventional and offshore crude oil and gas production, petroleum refining, and product marketing under the Petro-Canada brand.
Following the Petro-Canada acquisition in 2009, Suncor has become one of the largest owners of oil sands in the world. The company has gained new oil sands properties to supplement its existing operations in northern Alberta, making it the dominant producer in the region where reserves are second only to Saudi Arabia.
Additionally, Suncor explores, acquires, develops, produces and markets crude oil and natural gas in Canada and internationally, and it transports and refines crude oil and market petroleum and petrochemical products primarily in Canada.
Occasionally, Suncor also sells third-party petroleum products. The company carries out energy trading activities focused principally on buying and selling futures contracts and other derivative instruments based on the commodities it produce.
Suncor’s business can be divided into four segments: Oil Sands, Exploration and Production (E&P), Refining and Marketing, and Corporate, Energy Trading and Eliminations.
- Oil Sands: Suncor’s Oil Sands segment mines and upgrades oil sands in Canada’s Alberta province, to produce refinery-ready synthetic crude oil. In addition, the company has a 12.0% ownership interest in the Syncrude oil sands mining and upgrading joint venture, also located near Fort McMurray, Alberta. Production from this segment during 2013 averaged 392.5 thousand of barrels per day.
- Exploration and Production:This unitincludes offshore operations off the east coast of Canada and in the North Sea, and onshore operations in North America, Libya and Syria. In particular, Suncor has a strong position in every major producing oil development off Canada's east coast, including Hibernia, White Rose, Terra Nova, and Hebron.
- Refining and Marketing: Suncor’s Refining and Marketing segment operates refineries in Edmonton, Alberta, Montreal, Quebec, Sarnia, Ontario and Commerce City, Colorado with a total capacity of462,000 barrels per day, as well as a lubricants plant that is the largest producer of lubricant-base stocks in Canada. In addition, the unit markets refined products to retail, commercial and industrial customers mainly in Canada and Colorado through a combination of company-owned, branded-dealer and joint venture-operated retail stations, a large Canadian national commercial road transport network and a robust bulk sales channel. Other assets include interests in pipelines and product terminals in Canada and the U.S.
- Corporate, Energy Trading and Eliminations: This segment includes the company’s investment in renewable energy projects, results associated with third-party energy supply and trading activities and other activities not directly attributable to other operating segments.
REASONS TO SELL
Suncor Energy’s major focus lies in the production of crude from the Alberta oil sands. This is a high-risk strategy considering the higher costs associated with the extraction of oil from the oil sands compared to production from conventional oil wells.
Crude price has been showing weakness since Jul 2014. Moreover, we don’t expect any immediate spike in oil price in the coming months with the commodity being over supplied in the face of lackluster global demand. These are expected to considerably hamper Suncor’s upstream businesses as it will not be able to generate sufficient cash flows after selling crude at low prices.
Suncor’s deep oil sands technology, though proven, is still vulnerable to potential implementation delays, in our view. In particular, there are risks related to growth and other capital projects that depend wholly or partly on new technologies. The success of these projects remains uncertain. Additionally, the process of extracting crude from oil sand reserves is more expensive than conventional production.
After the Petro-Canada acquisition, we remain worried about Suncor’s high debt level (approximately C$12 billion) and significant anticipated capital expenditure requirements (aroundC$6.8 billion for 2014 and C$7.2−C$7.8 billion in 2015). This is expected to substantially increase Suncor’s leverage and deteriorate its credit metrics. Additionally, the increasing capital intensity of its operations may result in reduced returns going forward.
Environmental organizations argue that oil sand crude are greenhouse-gas intensive, thereby contributing to global warming. As such, there have been widespread regulations over Canada’s oil sands development in an attempt to stem global climate change and meet the country’s emissions-reduction goals. These policies could impact future profitability in the oil sand business.
RISKS
Suncor has significant oil sands and conventional production platform, huge long-lived oil-sands reserves and an impressive downstream portfolio. The company’s asset base includes substantial conventional reserves and production at offshore Eastern Canada and in the North Sea, which is capable of generating strong margins and free cash flows. Success on this front may adversely affect our recommendation.
As is the case with other exploration and production companies, Suncor’s results are directly exposed to oil and gas prices, which are inherently volatile and subject to complex market forces. Realized prices could differ significantly from our estimates, thereby affecting the company’s revenues, earnings and cash flows.
Suncor’s oil sand production has been rising at a record rate since the last four quarters. Importantly, the company expects 2014 and 2015 total oil sand production between 430−400 thousand barrels per day and 440−410 thousand barrels per day, respectively, significantly higher than the 2013 level. Hence, Suncor’s shares could outperform our target price.
RECENT NEWS
Third Quarter 2014 Results
On Oct 23, 2014, Suncor Energy reported third-quarter 2014 operating earnings per share of C$0.89 (US$ 0.82), which surpassed the Zacks Consensus Estimate of US$ 0.79. Higher production from the Oil Sands operations primarily aided the results.
However, comparing year over year, the bottom line declined 6.3% from C$0.95 per share, due to lower production and realization from E&P operations.
In the reported quarter, total revenue was C$10.27 billion (US$9.44 billion), down marginally from the year-ago level. The top line also failed to meet the Zacks Consensus Estimate of US$10 billion.
Quarterly operating earnings of C$1.3 billion were below C$1.4 billion recorded a year ago. Moreover, cash flow from operations decreased to C$2.3 billion from C$2.5 billion in the third quarter of 2013.
Production
Total upstream production in the reported quarter averaged 519,300 barrels of oil equivalent per day (BOE/d), down from the third-quarter 2013 level of 595,000 BOE/d. The result reflects impact of the sale of the conventional natural gas business, lower production from Libya and planned maintenance activity in E&P. However, the negatives were partially offset by better results from Oil Sands operations.
Oil sands volume was 411,700 barrels per day (Bbl/d), higher than 396,400 Bbl/d recorded in the year-ago quarter. Full functionality of the Firebag was the primary reason for the improvement. However, it was partially offset by unplanned maintenance activities and negative weather-related impact.
Production from Syncrude operations increased 8.1% year over year to 29,400 Bbl/d in the quarter as a result of lower planned maintenance activities.
Suncor’s Exploration and Production segment (consisting of International and Offshore and Natural Gas segments) produced 78,200 BOE/d, substantially lower than 171,400 BOE/d in the prior-year quarter. Sale of Suncor’s conventional gas operations, along with planned maintenance activities and reduced output from Libya, hampered the output.
The Refining and Marketing segment averaged 435,700 Bbls/d of refinery crude processed, down from 448,800 bbls/d in the year-ago quarter. The refinery utilization came in at 94%, lower than the year-ago quarter level of 98% primarily due to planned maintenance work at the Edmonton, Sarnia and Montreal refineries during the quarter.
Product Sales
The company’s refined product sales of 542,400 Bbls/d decreased 4.6% from the prior-year quarter.
Operating Expenses
Suncor reported operating cost of C$2.4 billion compared with C$2.3 billion in the year-ago quarter.
Balance Sheet & Capital Expenditure
As of Sep 30, 2014, Suncor had cash and cash equivalents of C$5.4 billion and total long-term debt (including current portions) of C$11.1 billion. The debt-to-capitalization ratio was approximately 20.9%. Moreover, the company incurred capital expenditure of C$1.7 billion in the quarter.
2014 Guidance
Suncor expects full year production in the 525,000–570,000 BOE/d range. The company expects refined products sale in the band of 500,000–550,000 Bbls/d.
The company maintains its 2014 capital spending guidance at C$6.8 billion.
Suncor Energy Prices Two Sets of Senior Notes
On Nov 20, 2014, Suncor Energy announced the pricing of two sets of senior notes offering.
The $750 million worth notes, with a maturity date of Dec 1, 2014 carried an interest rate of 3.60%. The offering closed on Nov 25.
Suncor Energy also announced the pricing of a medium-term offering. The C$750 million worth notes are due to mature on Nov 26, 2021 and carry an interest rate of 3.10%. These notes, yielding 3.154%, were priced at $99.663 per note. The offering closed on Nov 26.
The company stated that it plans to use the proceeds from both these offerings to improve its finances after the recent repayment of debt. Also, these funds will later be utilized for capital expenses and other corporate purposes.
Suncor Energy (SU) Provides Outlook for Operations in 2015
On Nov 18, 2014, Suncor Energy provided its production outlook and capital expenditure guidance for 2015.
Additionally, the company reconfirmed that its 2014 production is likely to be in the lower end of the 525,000–570,000 barrels of oil equivalent per day guidance. Also, the company expects the Oil Sands production to be below the lower end of its 400,000–430,000 barrels per day guidance.
2015 Capital Expenditure
Suncor Energy expects capital spending in the range of C$7.2 billion to C$7.8 billion.
A major portion of this amount (55% or about C$4.3 billion) is directed toward growth projects, which includes more than C$2 billion allocated for Oil Sands Projects. The remaining 45% or about C$3.5 billion will be utilized for achieving safe and reliable operations and improving efficiency.
2015 Production Outlook
The company anticipates average per day production of 540,000 to 585,000 barrels of oil equivalent.
Of this, 410–440 thousand barrels per day (bbl/d) are expected to be contributed by the Oil Sands Segment. Meanwhile, about 32–36 thousand bbl/d will likely be derived from the Syncrude segment while the remaining will come from the company’s exploration and production activities.
Refinery throughput from Eastern North America is likely to be in the 190–210 thousand bbl/d range, with utilization between 86%–95%. Refinery throughput from Western North America will expectedly be in the 220–240 thousand bbl/d range, with utilization between 92%–100%.
2015 Sales Guidance
Total Oil Sands Sales is expected in the range of 405–455 thousand bbl/d. Refined Product Sales is expected to be 500–550 thousand bbl/d.
VALUATION
Crude price has been plummeting since July this year. Hence, we don’t expect Suncor to generate sufficient cash flows from its upstream business amid the weak crude pricing scenario. We also remain concerned about the company’s high debt level and capital expenditure requirements.
These are reflected in our downgrade of the company’s shares to Underperform from Neutral.
Suncor’s trailing 12-month P/CF multiple is 5.1, compared to the 6.0 average for the peer group and 15.7 for the S&P 500. The company’s trailing 12-month EV/EBITDA multiple is 4.1, compared to the industry average of 53.1.
Our $28 price objective reflects a multiple of 4.6X trailing twelve-month cash flow.
Key Indicators
Earnings Surprise and Estimate Revision History
DISCLOSURES & DEFINITIONS
The analysts contributing to this report do not hold any shares of SU. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts’ personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1139 companies covered: Outperform - 16.1%, Neutral - 77.6%, Underperform – 6.0%. Data is as of midnight on the business day immediately prior to this publication.
Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company’s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock’s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively.
Analyst / Nilanjan BanerjeeEditor / Sudipta Mukherjee
QCA
Lead Analyst / Nilanjan Choudhury
Nilanjan Choudhury
Reasons for Update / Earnings Update
/ Equity Research / SU | Page 1