Thanks to the price of crude, it hasn’t been a good year for Canadian Oil Sands Ltd. (TSX:COS). Shares are down 70% and are flirting with all-time lows.
It hasn’t just been the price of crude affecting the stock. The company has had to deal with costs that were getting a little out of hand, an expanding debt load, and production issues at the Syncrude oil sands project, the company’s only source of production. And to make matters worse, there was recently a fire in the Mildred Lake upgrading facility, which will affect production for the next few weeks.
With crude still only hovering around $45 per barrel, it’s easy to be bearish on Canadian Oil Sands, especially in the short term. Even after recent cost cuts, it still costs between $40 and $45 per barrel to get the oil out of the ground. That doesn’t leave much profit, even if crude does head a little higher. At least the low Canadian dollar is helping.
Investors are primarily concerned with the negative free cash flow. The company had guided for $474 million in cash from operations in 2015, but only managed to post $146 million through the first half. That puts it on pace for just $292 million in cash from operations compared to $422 million in planned capital expenditures. That’s not sustainable in the best of times, never mind in a market where investors are convinced oil’s low price is here to stay.
After saying all that, this might sound strange, but I’m bullish on Canadian Oil Sands. In fact, I recently added to my position and maintain it’s still one of the best deals in the whole sector today. Here’s why.
Long-term bull
A few weeks ago, Canadian Oil Sands’s VP of Investor and Corporate Relations Siren Fisekci made the case for why investors should be bullish on the company at the Enercom Oil and Gas Conference in Denver.
The thesis goes something like this. It would cost between $80,000 and $120,000 per flowing barrel to build an asset like the Syncrude project from scratch, and that’s not even including the value of the upgrader on site, which converts the thick bitumen into something that very closely resembles light sweet crude. It doesn’t factor in reserves either, which are massive.
Canadian Oil Sands has an enterprise value of less than $40,000 per flowing barrel, which is less than half the cost needed to replicate the assets. Thus, even though the company’s shares trade for a small discount compared to book value, it’s really trading at about half of what book value should be.
It also offers huge leverage to an increasing oil price. According to Fisekci’s presentation. the company would earn $0.98 in cash flow from operations per share if oil increased to $55 per barrel. At $65 per barrel, the change is even greater, with $1.58 per share in projected cash from operations.
If crude increases approximately 50% from where it sits today, Canadian Oil Sands will see its cash flow from operations increase more than 400%. At today’s levels, the company not only offers great value, but also an option on just a modest increase in crude.
Balance sheet strength
One of the most important things a company in the midst of a turnaround needs is a solid balance sheet, especially one like Canadian Oil Sands’s. The company needs to be patient and wait for crude to head higher.
It’s obvious any calls of the company going bankrupt are very premature. Yes, the company does have some $2.4 billion in net debt, but none of that debt is due until 2019 at the earliest. That gives the company years to wait for the price of crude to recover.
Plus, the company has credit facilities in place for an additional $1.5 billion, which have recently been extended to 2019 as well. That’s easily enough to fund any shortfalls for the foreseeable future. Shortfalls shouldn’t be excessive either, since the company has slashed its dividend and been aggressive in cutting costs.
Over the short term, it’s easy to be bearish on Canadian Oil Sands. But over the next three to five years, there’s a good chance that oil will recover and the stock will head much higher.
