What’s Best of Breed in the Oil Patch?

Suncor’s been disappointing in recent years, but Fool contributor Robert Baillieul sees things turning around.

| More on:
The Motley Fool

How do you tell which companies are best of breed in the oil patch? Is it production growth, the price-to-earnings (P/E) ratio, or yield? No, the best metric in the investor toolkit is ROCE.

What the heck is ROCE?
One of the themes we have tried to emphasize here at Fool.ca is that growth for the sake of growth is not a desirable trait in a business. Sure, we like it when companies find new projects to grow profits — but only if they can generate a sufficient return to justify the risk. Otherwise, we shareholders would prefer if management paid us in nice dividends or share buybacks.

In the energy business, we have a very handy metric to determine how well management is allocating our capital: return on capital employed, or ROCE. I define ROCE as after-tax operating profit divided by the sum of debt plus shareholder equity.

Why is ROCE is so important? The ratio shows how much money is coming out of a business relative to how much cash is going in. This is important in industries that require a good deal of capital, such as oil and gas or semiconductor companies. In the energy business, ROCE is actually the preferred benchmark for comparing one company’s performance against another.

So who’s the best?
With that in mind, let’s take a look at which large Canadian energy company has done the best job managing shareholder capital.

Company ROCE 5-Year Average (%)
Imperial Oil 25%
Husky Energy 12%
Cenovus Energy 11%
Canadian Natural Resources 10%
Suncor Energy 8%

Source: Company filings

If this were a classroom, Imperial Oil (TSX: IMO) would be the teacher’s pet. But these results shouldn’t surprise anyone. Throughout the company’s history, Imperial’s executives have set a high bar to new investment by ensuring that only the most profitable projects receive funding. And when the company runs out of good opportunities, management has consistently returned excess capital to shareholders. While this strategy might not produce the biggest growth numbers, it’s the most profitable philosophy for shareholders funding the operation.

In contrast, Suncor (TSX: SU, NYSE: SU) is the class clown. This might be shocking for some, given that Suncor was one of Canada’s fastest-growing companies over the past decade driven by the Petro-Canada acquisition and oil sands expansion. But shareholders have paid the price for this growth. To expand, Suncor had to fund lots of low-return projects and reckless spending led to cost overruns. If that money had instead been paid out, investors might have found better opportunities elsewhere.

Should you bet on the teacher’s pet?
However, Suncor is getting its act together under the company’s new Chief Executive Steve Williams. Since taking the helm last year, Williams has abandoned his predecessor’s production targets, implemented a 15% return hurdle rate on new projects, and ramped up dividends and share buybacks. These measures should boost Suncor’s ROCE in the future.

In contrast, I’m worried that Imperial is skipping class. The company’s new Chief Executive Rich Kruger is talking about bold production targets rather than shareholder returns. Imperial is looking to double output to 600,000 bpd by 2020. And recent cost overruns at the company’s Kearl oil sands project should be alarming.

Foolish bottom line
It can’t be emphasised enough — growth for the sake of growth is not a desirable quality in a company. As shareholders, we don’t want to hear that executives are using our capital to build empires. Rather, management teams that deploy our capital the most efficiently should be judged as the best.

The Motley Fool’s top two stock ideas
The Motley Fool Canada’s senior investment analyst just unveiled his top two stock ideas for new money now. And YOU can be one of the first to read his buy reports — just click here for all the details.

Disclosure: Robert Baillieul has no positions in any of the stocks mentioned in this article. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

More on Investing

investor looks at volatility chart
Stocks for Beginners

Market Dip: Opportunity or Risk This May?

If you're worried about the markets this May, then let's look at what Canadian stocks to consider.

Read more »

Canadian Red maple leaves seamless wallpaper pattern
Dividend Stocks

Tariff Turmoil: This Canadian Stock Is a Buying Opportunity

This Canadian stock is a buying opportunity because of the long-term viability of the business, notwithstanding the tariff turmoil.

Read more »

hand stacks coins
Dividend Stocks

TFSA Investors: 2 Blue-Chip Stocks to Buy and Hold Forever for Tax-Free Wealth Growth

Consider adding these two giants from their respective industries if you’re on the hunt for long-term investments in a self-directed…

Read more »

calculate and analyze stock
Dividend Stocks

Top Canadian Stocks to Buy Now With $5,000

Investing in blue-chip Canadian stocks such as Dollarama should help you deliver outsized gains in 2025 and beyond.

Read more »

clock time
Investing

Canadian Tire to Buy Assets From This Legendary Canadian Company: Time to Buy the Stock?

Canadian Tire (TSX:CTC.A) just inked a $30 million deal to acquire some very prestigous brands from Hudson's Bay Company.

Read more »

Canada national flag waving in wind on clear day
Investing

2 Canadian Stocks With Good Insulation From Trade Tensions

Here's why I think Shopify (TSX:SHOP) and Brookfield Asset Management (TSX:BAM) are two top stocks to buy for those concerned…

Read more »

stock research, analyze data
Dividend Stocks

Where to Invest $8,700 in the TSX Today

These stocks still trade at discounted prices.

Read more »

Pile of Canadian dollar bills in various denominations
Dividend Stocks

Transform Your TFSA Into a Cash-Crushing Machine With $15,000!

This stock can be one of the best options for investors looking for growth, income, and so much more.

Read more »