An oil rebound is coming. When it does, Suncor should benefit more than most energy stocks.
The price of oil has declined due to an increase in production from U.S. shale oil producers, and Saudi Arabia refused to decrease production as a way of stabilizing prices. Despite these two facts, I believe oil prices will rebound because of certain fundamental factors such as an increase in demand.
While oil demand may be weak right now, that won’t be the case in the future. According to the Energy Information Industry (EIA), world oil consumption is expected to increase 38% by the year 2025. That increase should start this year.
Another reason low oil prices can’t be sustained is because of production costs.
According to this chart from Bloomberg, the break-even point for most shale oil producers in the U.S. is $80 per barrel. If these $50 oil prices persist, most of the shale oil producers will go bankrupt and supply would contract significantly. That’s not likely to happen.
Saudi Arabia would also go bankrupt if these low prices hold. For Fiscal Year 2014, Saudi Arabia is estimated to have its first annual budget deficit since 2011, a shortfall of some $38.6 billion, with plans to increase government spending in 2015. Ninety percent of Saudi Arabia’s government revenues come from oil exports.
I am not sure how much longer this low oil price environment will last, but I do know Suncor (NYSE: SU) will be able to survive the current environment because of its business model.
Suncor is a vertically integrated company, which means it possesses upstream (exploration and production), midstream (pipeline and transportation) and downstream (refining) assets. This is important because midstream and downstream components of the oil business aren’t as oil-price sensitive when it comes to profit outcome. Suncor will also survive this low-price environment due to its low production cost of $34.50 per barrel.
Survival is one thing. Thriving is another. When market sentiment changes and oil prices start to increase, Suncor should thrive because of its strong balance sheet, commitment to increasing shareholder value, and production growth.
Let’s start with the latter attribute. Suncor expects to increase its oil production from 430,000 barrels of oil per day to 550,000 by 2017.
As for its balance sheet, in the last four years Suncor’s capital expenditure program (CAPEX) has been funded from its operating cash flow. In the third quarter of 2014 alone, Suncor generated a total of $3.1 billion dollars of free cash flow, a $1 billion dollar increase from 2013’s third-quarter cash flow results.This generation of free cash flow would allow Suncor to expand and grow its operations, and return money directly back to shareholders in the form of dividends or share repurchase programs.
Speaking of which, Suncor has demonstrated its commitment to increasing shareholder value by increasing its dividend at a compounded annual growth rate (CAGR) of 40% over the last five years, while implementing a share repurchase program of 9% of its outstanding shares.
For these reasons, I believe Suncor is a sound way to profit from the next upswing in oil prices. Until that happens, the stock’s 3% annual yield at least pays you to wait.
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