Suncor Energy (TSX:SU) is Canada’s largest integrated oil and gas company. Not too long ago, it was celebrated as the go-to name for energy exposure. But over the last few years, everything changed. Today, investors are largely indifferent with regard to Suncor stock, as they have turned on the stock they once loved.
In this article, I will explore this reversal and re-visit the investment thesis for Suncor stock.
Suncor benefits from its integrated model
What does an integrated oil and gas company mean? What are its advantages?
An integrated oil and gas company is a company that has operations in different segments of the industry. This includes exploration and production as well as refining and marketing. Exploration and production are pretty self-explanatory. This is the business of exploring for and extracting the oil and gas out of the land. The business is exposed to the oil price, as this is what it receives for its production sold.
Next is the refining business, which takes the crude oil and refines it into finished products such as gasoline, heating oil, and diesel fuel. Unlike the production business, this business is exposed to the pricing of the finished products. These prices can move in tandem with crude oil, but they have their own pricing mechanism, which is reliant on supply/demand fundamentals.
So, as you can see, this integration leads to a diversified business that is not only at the mercy of oil prices. It’s also exposed to the fundamentals of the petroleum products that it produces from crude oil. These two businesses often work to offset one another, providing greater stability in the company’s overall results.
Beating expectations
Suncor’s third-quarter earnings per share result came in strong — almost 12% better than expected. Also, adjusted funds from operations came in at $3.6 billion, and operational improvements boosted efficiencies.
This was a function of a strong business environment, which saw strong oil prices of over $80 and strong refining margins, as upgraders achieved over 100% utilization. Also, the price of Suncor’s key input cost, natural gas, remains low.
Suncor stock price: Low valuation
At this time, Suncor’s stock price continues to trade at very depressed valuations. For example, it’s trading at eight times this year’s expected earnings and seven times next year’s. Also, it trades at a mere 1.3 times book value, despite the fact that Suncor’s return on equity, or ROE, is an impressive 20%.
This valuation strikes me as extremely low for a company like Suncor, whose core business is a strong one. This business has consistently generated strong cash flows, strong returns, and growing shareholder value creation.
For example, in the last 10 years, Suncor’s annual dividend has increased 300% to the current $2.18. That’s a compound annual growth rate of 15%. And for us long-term investors, Suncor’s 20-year dividend history is even more impressive — a 2,000% dividend increase over that period. In the oil and gas industry, which is notorious for major swings in commodity prices and company cash flows, this is all the more impressive.
The bottom line
Predicting oil and gas prices is notoriously difficult. But Suncor is a very profitable and undervalued energy stock that has proven itself over the years. I think now is a good time to buy.
