Is Canadian Oil Sands Ltd. Being Too Greedy?

In rejecting Suncor Energy Inc. (TSX:SU)(NYSE:SU), Canadian Oil Sands Ltd. (TSX:COS) has a lot to lose.

| More on:
The Motley Fool

When Suncor Energy Inc. (TSX:SU)(NYSE:SU) launched a bid to acquire Canadian Oil Sands Ltd. (TSX:COS) it was clearly being opportunistic in its approach. Canadian Oil Sands’s stock had been hammered over the past year as persistently weak oil prices, along with its debt-laden balance sheet, sent its stock down by more than 65% before Suncor made an offer.

However, in not only outright rejecting, but now fighting that deal, Canadian Oil Sands is walking a fine line because the fact of the matter remains is that it still has a lot of debt and negative cash flow. In other words, it might be getting a little too greedy.

Numbers don’t lie

As the chart below shows, Canadian Oil Sands’s net debt has ballooned to more than $2 billion since the onset of the downturn.

COS

As a result of this ballooning debt, Moody’s downgraded its credit rating to one notch above junk, specifically citing the deterioration of the company’s balance sheet. Further, it pointed out that the company was expected to generate negative cash flow of $125 million over the next 15 months that would also largely be funded by more debt. That would likely trigger another credit downgrade, this time to a junk rating.

This lack of cash flow fueled whispers in the market place that the company was looking for alternatives such as selling its future production in order to bring in some cash. While the company quickly shot down those rumours, the fact remains that it’s struggling under the current oil price. It’s a price that has yet to show too many signs of improving. In other words, if oil prices do stay lower for longer, Canadian Oil Sands will only continue to struggle.

A tale of two companies

Suncor Energy, on the other hand, is generating almost as much cash flow now as it was when oil prices were higher. In fact, it’s generating so much cash flow that it has a surplus on its balance sheet. That’s why the company said it was on the lookout for acquisitions. Further, CEO Steve Williams specifically said that he was looking for an opportunity to acquire assets in a fire sale brought about by low oil prices.

That’s exactly where we find Canadian Oil Sands. It’s a company that has too much debt for the current oil price, and is running an unsustainable business if the current oil price is the new normal. Further, if oil prices were to really collapse (some are warning that $20 per barrel isn’t out of the question), that would put Canadian Oil Sands on precarious footing.

There’s a growing risk that it might not survive if a wave of bankruptcies sweep through the energy sector, which is a growing risk if oil remains weak and credit starts to tighten.

Investor takeaway

There’s no denying that Suncor Energy is making an opportunistic offer to acquire Canadian Oil Sands as the company has been waiting patiently for the opportunity to go shopping for assets at fire sale prices.

However, given Canadian Oil Sands’s rising debt levels, and the fact that oil prices might not recover for a while, this might just be the best offer the company receives. It’s running a real risk of being too greedy at a time when its financials are deteriorating. If oil prices take another leg down, or credit really tightens in the sector, the company might regret fighting to remain independent.

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 Matt DiLallo has no position in any stocks mentioned.

More on Energy Stocks

Arrowings ascending on a chalkboard
Energy Stocks

Beat the TSX With This Cash-Gushing Dividend Stock

Canadian Natural Resources stock is well set up to beat the TSX as it continues to generate strong cash flows…

Read more »

energy industry
Energy Stocks

2 TSX Energy Stocks to Buy Hand Over Fist Now

These two rallying TSX energy stocks can continue delivering robust returns to investors in the long term.

Read more »

green energy
Energy Stocks

1 Magnificent TSX Dividend Stock Down 37% to Buy and Hold Forever

This dividend stock has fallen significantly from poor results, but zoom in and there are some major improvements happening.

Read more »

oil tank at night
Energy Stocks

3 Energy Stocks Already Worth Your While

Here's why blue-chip TSX energy stocks such as Enbridge should be part of your equity portfolio in 2024.

Read more »

Solar panels and windmills
Energy Stocks

1 Beaten-Down Stock That Could Be the Best Bet in the TSX

This renewable energy stock could be one of the best buys you make this year, as the company starts to…

Read more »

Dice engraved with the words buy and sell
Energy Stocks

Is Enbridge Stock a Buy, Sell, or Hold?

Here's why Enbridge (TSX:ENB) remains a top dividend stock long-term investors may want to consider, despite current risks.

Read more »

Gas pipelines
Energy Stocks

If You Had Invested $5,000 in Enbridge Stock in 2018, This Is How Much You Would Have Today

Enbridge's high dividend yield hasn't made up for its dismal total returns.

Read more »

Bad apple with good apples
Energy Stocks

Avoid at All Costs: This Stock Is Portfolio Poison

A mid-cap stock commits to return more to shareholders, but some investors remember the suspension of dividends a few years…

Read more »