Category: Canada

A briefing note. I do not think any of this thinking below is original by any means, but it needs to be said.

On May 26, Suncor (TSX: SU) guided at WTIC US$60 in 2021 and US$55 in 2022 (which is presently US$68 and US$62 for the year-end contracts, respectively) a free cash flow of $7 billion. This is after a $3 billion capital expenditure in 2021.

The guidance was notable in that the 9 megabyte slide deck they provided went through great pains to downplay the amount of cash they actually were going to generate (in typical Canadian fashion, it is like they are embarrassed to admit they are making this much money), but let’s play along.

Suncor’s enterprise value is about CAD$60 billion, about $45 billion market value and $15 billion debt.

Let’s do some basic math. This is grade school finance.

It means if the company can produce cash at the present rate (which, in general, they can given the nature of what they are mining at the present capital expenditure rate), if directed to debt and equity, they will be able to pay off all their debt and repurchase their entire share stack (at current prices – it will rise over time) in 8.5 years.

This doesn’t include changes in the selling price of oil, which the above figure is currently below market.

This is a little more complicated to calculate the sensitivity to commodity pricing. Companies give out sensitivities and for every dollar on Brent (not quite WTIC, but deeply correlated), Suncor changes its funds flow through operations by about CAD$300 million. Very roughly, subtract royalties and taxes (no more tax shield, they made too much money already) and it is about CAD$200 million leftover.

I note that at current pricing, an $8 positive oil price difference over the model (note: do not confuse with the Canada/USA differential) changes the 8.5 years alluded to above into about 7 years.

You just need to make the assumption that oil pricing will stay steady.

If this is the case (or heaven forbid, oil rises even further), Suncor is ridiculously undervalued.

This doesn’t even factor in the WCS/WTIC differential, which is likely to close once Line 3 is completed (end of the year) and TMX is finished (2022?). This will be the freest money for all stakeholders involved. An extra US$5 off the differential (it is now about US$15) on Suncor’s capacity is about US$1.5 billion a year – suddenly 7 years now becomes 6 years.

Not surprisingly, the company is buying back stock like mad, probably because there isn’t anything else they can really do with the excess cash flow.

In the past couple months, they’ve bought back US$375 million in stock, 17.2 million shares (about 1.1% of the outstanding). They should aim to buy back the maximum they can at current pricing.

As this continues, the stock price will rise and make future buybacks less attractive. After the appreciation, they should jack up the dividend.

Normally businesses would also invest in capital expenditures, but in Canada, we are closed for business for any significant natural resource projects. We mine what we have left, which makes the decisions easy – harvest cash.

What is the thesis against this?

The obvious elephant in the room is the sustainability of oil pricing.

I have no doubt in 100 years from today that fossil fuel consumption, one way or another, will be seriously curtailed. It will likely be too expensive to use in most applications that we see today.

But in 8.5 years? Get real. Oil sands reserves are measured in decades.

The other obvious component of “Why are they letting me have it so cheap?” is political correctness in the form of ESG. Much demand is sapped because of this. Many institutions cannot touch oil and gas, including Berkshire Hathaway.

Eventually through buybacks and dividend payments, the market will adjust this.

The margin of safety here is extremely high and nothing comes close in the Canadian marketplace, at least to anything with over a billion dollar market cap.

The same reasoning above also applies to Canadian Natural Resources (TSX: CNQ) and Cenovus (TSX: CVE). They are also in the same boat in terms of their FCF/EV valuation, and also with similarities in their operations. Once they reduce leverage, they will be buying back stock like crazy if it is still at the current price. I don’t know how long this will last.

Sometimes things are so obvious in the markets you really wonder what the trick is, but with this, it is the closest thing I can think of picking up polymer cash notes on the street. Efficient market theory would tell me that those cash notes wouldn’t be there. Perhaps traditional finance theorists might be right, we will see. At least I can take some solace when I am at the gas station and seeing record-high prices.