In the fall, bullish investors were loading up on energy stocks, convinced that this sell-off would be just like the one in 2009—short-lived and ending in a massive recovery. I was one of them.
Then, as January moved into February, and then to March, nothing happened. Energy stocks just stagnated.
Now that it appears that energy could be in a bear market longer than most of us anticipated, impatient investors are beginning to speculate on potential consolidation stories. This speculation is further fueled by the performance of each class of energy company. The majors with great balance sheets have held up quite well, while the intermediate and smaller players have seen their share prices cut by as much as 90%, especially those with a high cost of production.
One company that’s the centre of many take-out rumours is Canadian Oil Sands Ltd. (TSX:COS), the largest owner of the Syncrude oil sands project. Its 37% share of the project works out to approximately 100,000 barrels of oil in production per day, assuming things are going well. 2014 was plagued with issues, meaning 2015’s outlook is a little on the low side, at approximately 95,000 barrels per day.
Unlike the other oil sands producers, the Syncrude project uses an upgrading system to turn bitumen into something really close to light sweet crude. This means a higher price received for the commodity, but it also means higher costs.
While some oil sands producers enjoy costs of less than $20 per barrel, Canadian Oil Sands recently reported costs of $47 per barrel, and that doesn’t even include things like royalties or depreciation. All in, it has a cost of approximately $65 per barrel. With crude hovering around the $50 mark, it doesn’t take a genius to realize the company isn’t in great shape.
The company has taken some cash-cutting steps, including cutting its dividend from $1.40 per share annually to $0.80, and then finally to $0.20. It also plans to defer some capital maintenance expenses this year, as well as cutting costs on the operating side, but that’s more difficult since Imperial Oil is the project’s operator.
From a short-term perspective, things don’t look great for the company. Basically, it needs oil to recover quickly to get back to the point where it’s actually making money again. But from a long-term perspective, this could be a great time to buy.
Look at it this way. The company currently has 1.6 billion barrels of proved and probable reserves, along with another 1.7 billion that could be recovered at some point in the future, called contingent reserves. Based on an enterprise value of $7.1 billion, investors are paying just $4.43 per barrel of proved and probable reserves, while getting billions worth of equipment, upgrading technology, and contingent reserves for free. When oil recovers and Canadian Oil Sands starts to trade based on its earnings again, this will look like a great deal.
Which is exactly why investors think a buy out of the company may be coming. However, these investors are missing a couple of important points.
First of all, it would take a nice premium to market value to win over shareholders. I think it would take a minimum of $15 per share, which is $7.3 billion. Add the company’s $1.9 billion in debt, and that’s a commitment of nearly $10 billion. That’s a lot of money to raise in a weak energy market, especially during a time when competitors like Cenovus are having trouble raising a mere $1.5 billion to shore up its balance sheet.
I’m not sure shareholders would vote for a takeover at this stage. Many have held this stock for years, enjoying the dividend during good times and patiently waiting when times get tough. Some of the more recent buyers of the stock are value investors, who see huge upside when oil returns to normal levels. Neither group seems likely to get excited about an offer during a vulnerable time.
Besides, takeover offers hardly ever happen at the bottom of the market; they happen when things are booming. During periods like this, companies are more likely to hang on to their cash.
Canadian Oil Sands deserves a spot in your portfolio because it’s a really cheap way to buy some great oil assets. Just don’t count on it being acquired.
