The Motley Fool

Why I’m Buying Canadian Oil Sands Ltd. (Even After the Dividend Cut)

Canadian Oil Sands Ltd. (TSX: COS) has been on my watch list for months.

Canadian Oil Sands represents a 36.74% ownership interest in the Syncrude project in Northern Alberta. The other two-thirds of the project is owned by such heavyweights as Imperial Oil (25%), Suncor (12%), and a handful of others. The project has been operational since 1977, with Canadian Oil Sands’s portion of production coming in at approximately 100,000 barrels of oil per day.

Unlike other oil sands projects, Syncrude upgrades its production on site, running it through a series of processes that turn the thick, tar-like bitumen into something close to light sweet crude, which is much easier for refineries to deal with. It adds a cost to the whole operation, but it results in a sale price very close to the price of WTI. This is usually in the neighborhood of $20 per barrel of extra revenue compared to other oil sands operators.

Naturally, this process adds extra costs to the equation, especially lately. Over the last few years, Canadian Oil Sands has been forced to make major repairs on four out of five upgraders, to the tune of a few billion dollars. This is projected to improve in 2015, as capex is expected to drop nearly $500 million to about $550 million in 2015.

But even though capital expenditures are forecasted to be lower, management still reacted to low crude prices by cutting the company’s $0.35 per share quarterly dividend by nearly 50%, to $0.20. There are likely to be many dividend investors disappointed by the decision.

But one quick look at the company’s projected 2015 numbers shows the dividend cut was a prudent move. If oil averages $75 per barrel in 2015, Canadian Oil Sands will have a projected operational cash flow of $730 million. Subtract the $550 million in capital expenditures, and you have $180 million available to pay shareholders. That works out to about $0.40 per share available to pay a dividend worth $0.80 annualized going forward.

Why would I place confidence in a company only projected to earn about half of its dividend going forward?

There are a few reasons, actually. The first one is pretty simple — I do not believe that we’ll see oil under $80 for a significant period of time. World production is too expensive for oil to stay this low. There aren’t many producers who can make money at $65 oil.

Secondly, I believe the company can cut costs. 2015’s projections call for an operating cost of approximately $47 per barrel, which is as high as its ever been. There’s plenty of fat to cut out of operations, starting with staff, and 2015 looks to be a year where worker supply will finally overtake demand, which should suppress wages.

And finally, there are the company’s massive reserves. Based on a production estimate of 100,000 barrels of oil per day, Canadian Oil Sands’ share of the Syncrude project has enough reserves to keep production going for an additional 45 years. That’s a long time.

Or, looking at it another way, Canadian Oil Sands has approximately 1.6 billion barrels of proved and probable reserves. Based on the company’s enterprise value of $8.1 billion, I’m paying just over $5 per barrel of oil in the ground. That’s as cheap as the company’s been in years.

I’m writing this before the market opens on Thursday morning. I strongly suspect that many dividend investors will be throwing in the towel on Canadian Oil Sands, causing shares to sink even further. If that happens, I couldn’t be happier. I’ll be there, scooping up as many as I can afford. I’m not about to let this opportunity go to waste. Perhaps you should join me.

Just Released! 5 Stocks Under $49 (FREE REPORT)

Motley Fool Canada's market-beating team has just released a brand-new FREE report revealing 5 "dirt cheap" stocks that you can buy today for under $49 a share.
Our team thinks these 5 stocks are critically undervalued, but more importantly, could potentially make Canadian investors who act quickly a fortune.
Don't miss out! Simply click the link below to grab your free copy and discover all 5 of these stocks now.

Claim your FREE 5-stock report now!

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.

Fool contributor Nelson Smith has no position in any stocks mentioned, but he does intend to buy shares of Canadian Oil Sands Limited. 

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss an important event.

Iain Butler and the Stock Advisor Canada team only publish their new “buy alerts” twice a month, and only to an exclusively small group.

This is your chance to get in early on what could prove to be very special investment advice.

Enter your email address below to get started now, and join the other thousands of Canadians who have already signed up for their chance to get the market-beating advice from Stock Advisor Canada.