The Motley Fool

Why I Remain Bearish on Canadian Oil Sands Ltd.

One time high-flying, dividend-favourite Canadian Oil Sands Ltd. (TSX:COS) has been savaged by the oil rout. The rout has caused it to slash its dividend as oil prices fell lower than management initially expected. This triggered a sharp sell-off that made its share price plunge to lows not seen for over a decade.

However, since then it has bounced back, more than doubling in value on the back of takeover rumours and an improving outlook. This has left many investors considering whether now is the time to invest. 

Now what?

Canadian Oil Sands is pure leveraged play on higher oil prices. All of its oil production is unhedged, thereby reducing costs and creating the potential for considerable upside should oil prices rebound. Yet there are considerable risks for investors because Canadian Oil Sands is exposed to the vagaries of crude prices.

However, the one aspect of its operations that continues to attract considerable attention is its long-life oil reserves. These reserves total 1.4 billion barrels after allowing for royalties and have an independently assessed value after income taxes and the application of a 10% discount rate of $9.2 billion.

After deducting net debt totaling $1.6 billion, this equates to a value of $15.60 per share, or a 29% premium over Canadian Oil Sands current share price. It is this that makes Canadian Oil Sands an attractive takeover target and investment in the eyes of some analysts and investors.

Nonetheless, I certainly wouldn’t count on Canadian Oil Sands becoming a takeover target, even if oil prices remain depressed. With an enterprise-value of almost $8 billion, it would be a tremendous acquisition for any major oil company to digest.

I am also yet to be convinced that Canadian Oil Sands offers investors a deep-value investment opportunity.

You see, the Syncrude project over the years has been plagued by operational problems; a range of production outages has caused oil production to be lower than forecast. These production outages, along with ongoing maintenance issues, have also caused costs to grow, further impacting Canadian Oil Sands profitability.

All of these issues can be attributed to the complex nature of the machinery required to convert bitumen into synthetic crude. While Canadian Oil Sands and its Syncrude partners have taken considerable steps to improve the reliability of the operation and reduce costs, I am yet to be convinced that its reliability has improved.

Canadian Oil Sands also has a massive $8 billion in financial obligations, of which, $2 billion falls due over the next four years. When the current harsh operating environment is considered, these financial obligations could have a significant impact on Canadian Oil Sands financial condition. If oil prices remain low for longer than expected, I would expect to see its financial condition deteriorate further, forcing it to make additional cuts to expenditures, including its dividend.

So what?

Canadian Oil Sands’ long-life oil reserves make it an attractive investment.

However, I don’t believe this is sufficient to make it a worthwhile investment at this time because there are too many issues relating to its financial health and operational sustainability that leave it particularly vulnerable in the current harsh operating environment.

Looking for a reliable energy stock that has proven itself resilient to the collapse in oil prices? Then you don't want to miss this energy stock!

Every portfolio should have rock-solid blue chips at its core and if it doesn't then you might want to reconsider your strategy.

This energy stock is a leading Canadian blue-chip that has shown itself to be resilient to the oil rout and has paid a steadily growing dividend for decades. For these reasons and more our analysts have identified it as one TOP stock for 2015 and beyond—a stock with a tollbooth-like business; a solid management team; and a reliable, consistent, and rising dividend—and you can download the name, ticker symbol, and price guidance absolutely FREE.

Simply click here to receive your Special FREE Report, “1 Top Stock for 2015—and Beyond.”

Fool contributor Matt Smith has no position in any stocks mentioned.

I consent to receiving information from The Motley Fool via email, direct mail, and occasional special offer phone calls. I understand I can unsubscribe from these updates at any time. Please read the Privacy Statement and Terms of Service for more information.