Higher oil prices are giving Suncor Energy (TSX:SU)(NYSE:SU) the necessary boost to generate better margins and improve its profits. Indeed, investors who missed the rally in Suncor stock last year are probably wondering if this company is still undervalued and deserves to be on their watch list.
In my view, it is. Let’s see why.
Increasing profit margins bullish for Suncor stock
As a commodity-focused business, Suncor’s attractiveness is largely a function of its fundamentals. When commodity prices are high, Suncor will do well. When energy plunges, the inverse is also true.
Thus, it’s unsurprising to see the volatility in Suncor stock we’ve witnessed in recent months. With oil prices surging, Suncor is seeing profit margins shoot through the roof. This is obviously a positive for long-term investors and a nice change from what we saw last year.
Suncor’s cost per barrel hovers around $35 West Texas Intermediate (WTI). This low cost of production relative to where the price of oil trades at today means Suncor is spewing out cash flow at tremendous levels. These cash flows are necessary to fund capital spending projects as well as dividends over time.
Indeed, the focus Suncor has had on creating operational efficiencies and reducing costs is reflected in excellent margins. These margins have also flowed through to high-quality earnings of late.
Indeed, the company’s Q1 2021 performance is impressive. Thanks to rising oil prices and improved operating expenses, net earnings came in at $821 million. These earnings were a stark improvement from last year’s whopping $3.53 billion in the same quarter. Funds from operation stood at $2.11 billion, up from $1 billion year-over-year.
Suncor reduced its debt by nearly $1.1 billion, along with repurchasing 1% of its outstanding shares using excess cash. True, Suncor did not increase its dividends since the company’s 55% cut back in 2020. Its 2.9% dividend yield is certainly not the greatest among its peers. However, improving cash flow can be key to future dividend growth.
Suncor is a company that is on solid financial footing right now. The cash flow Suncor is generating makes this stock appear to be very undervalued compared to many of its peers. Indeed, for investors who believe commodity prices will remain strong for some time longer, Suncor could have more room to run.
As energy demand continues to increase coming out of this pandemic, Suncor and other pure-play energy producers stand to benefit. These high-leverage plays are starting to look attractive right now, and investors would be remiss to pass up an opportunity to research these further.
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 Chris MacDonald has no position in any stocks mentioned in this article.