Over the past handful of years, you’ve needed nerves of steel to invest in the oil and gas sector. The price of West Texas Intermediate (WTI), the benchmark for the price of oil, was trading above US$75 per barrel (pb) at the start of the decade and spent several years popping above US$100 pb. Then the price crashed, and WTI touched multi-year lows in 2015. Although the price of oil has gradually started to recover, there still exists considerable volatility.
For its part, the S&P/TSX Capped Energy Index hasn’t fully recovered from the mid-decade crash. In fact, the index continues to struggle and posted multi-year lows in late 2019. This is in spite of a decent recovery in the price of oil WTI prices.
There are a number of headwinds facing Canadian producers. At times, pipeline contraints have led to a big price differential between Western Canadian Select (heavy crude) and WTI prices. At times, the price was so significant that producers were producing at a loss, despite the recovery in WTI prices. This led to a number of strategies, including shipping oil by rail and production curtailments by the government of Alberta. The latter proved to be yet another headwind for the industry.
Negative sentiment persists, as public policy has failed to ease, and, in certain cases, have compounded the headwinds facing Canada’s oil patch. It is for this reason that investors remain skeptical and have thus far shied away from investing in Canada’s oil and gas industry. The end result? Companies are trading at valuations not seen in over a decade.
Contrarian investors will recognize this as an opportunity to get in on the bottom floor. The best way to play the industry is to invest in blue-chip, high-quality companies that are best prepared to weather any prolonged bear market. A company such as Suncor (TSX:SU)(NYSE:SU) is a good way to position your portfolio for outsized gains in the event of an industry rebound or to protect it against considerable downside in the event the industry continues to struggle.
Despite tough times, Suncor’s share price has averaged 4.41% annual returns over the past five years. This is above the S&P/TSX five year annual average of 3.6% and crushes the negative returns posted by the S&P/TSX Energy Index (-5.31% annual average).
Suncor is a low-cost producer which generates considerable cash. Over the past five years, funds from operations (FFO) were more than sufficient to cover capital expenditures and the dividend. In fact, the company even generated positive free cash flow throughout the most recent bear market. This has enabled to company to remain one of the best income stocks in the industry as a Canadian Dividend Aristocrat.
This oil major has an attractive starting yield (3.94%) and has grown the dividend for 17 consecutive years. The company is expected to grow FFO by an average of 5% annually through 2023, and the dividend is expected to grow in line with FFO. Safe and reliable income is one of the reasons why Suncor is considered one of the industry’s best. It is also the main reason why it remains a top energy pick for 2020.
