Despite crude prices tanking over the last 3 months, Wall Street continues to bet big on oil. One company which has attracted the attention of some of the world’s most famed investors is Canadian integrated energy giant Suncor Energy Inc. (TSX: SU) (NYSE: SU).
Between them, Warren Buffet, Joel Greenblatt and Ray Dalio have invested almost US$656 million in Suncor. Buffett’s investment alone makes up US$640 million of that amount and accounts for 1.1% of Suncor’s share float.
But given the recent rough handling of crude prices coupled with fears they will tank further, the big question for investors is, should they follow suit? Despite these fears I believe with its share price down by 14% over the last three months, Suncor represents a solid long-term opportunity.
Let me explain why.
Inelastic demand
Petroleum in its various forms is a key component of our modern lives and economies, powering transportation, and electricity generation as well as being used in a wide range of manufacturing processes. For these reasons oil companies do not need to market their product, but rather prices are set by global supply and demand. While a glut in global supply coupled with a slump in demand from major economies including the Eurozone and China continues to push crude prices down, over the long-term, it’s reasonable to assume this won’t last.
This rebound will come on the back of growing economic activity in some of the world’s largest emerging economies including India, Brazil and South East Asia, along with an eventual economic recovery in China and the Eurozone. Furthermore, global supply is set to decline over the long-term as production from the U.S. shale oil boom starts to taper off after 2020.
Both of these factors will help to drive oil prices higher over the long-term.
Suncor’s business is extremely difficult to replicate.
Suncor is Canada’s largest integrated oil major. “Integrated” means means it has upstream, or oil exploration and production, operations coupled with downstream refining and marketing operations.
In order to enter the oil industry particularly as an integrated energy major a significant capital investment is required. In addition, there are significant regulatory and other operational hurdles to overcome. All of these factors help to create a wide multifaceted economic moat which protects Suncor’s competitive advantage.
Furthermore, by virtue of being an integrated energy major with significant downstream operations, Suncor has significant advantages over companies that are purely upstream producers of crude. Its refining operations allow it to better manage lower crude prices as well as pricing differentials between Canadian crude blends and WTI. In turn, this allows Suncor to maximize the margins across its entire business.
Regular dividends and attractive multiples
Currently, Suncor is trading with an enterprise-value (EV) of a mere 5 times EBITDA coupled with a forward price-to-earnings ratio (P/E) 10. I believe these multiples make it a relative bargain for investors.
In addition, Suncor’s paid a dividend every year since 1992 and hiked that dividend for the last four consecutive years. This gives it a tasty 2.8% dividend yield, which is certainly sustainable with a payout ratio of 54%. Since inception, Suncor’s dividend has a compound annual growth rate of 13%, which is well above average annual inflation rate for that period and a superior rate of return than many other investments.
It is not hard to see why Buffett has amassed such a large stake in Suncor and while crude prices may be depressed with an uncertain outlook, Suncor is an attractive bargain which has solid long-term growth prospects.
