This week it was announced that legendary value investor Warren Buffett had taken a relatively small ($500 million) position in oil sands producer Suncor Energy Inc. (NYSE:SU) (TSE:SU). While this announcement attracted much speculation and indeed anger over environmental issues, Suncor is in fact just a good old value play.
First a quick overview of Suncor Energy Inc. (NYSE:SU) (TSE:SU), the company is a vertically integrated oil producer, producing oil from oil sands (377,000 bbls/d) and offshore fields internationally (134,000 bbls/d). The company has refining capacity to refine 89% of its oil production and midstream operations with the capacity to move 100+ million barrels around the globe.
Suncor Energy reserves will last to 2047
Currently, Suncor Energy Inc. (NYSE:SU) (TSE:SU) is highly profitable, cash generative and set to stay this way for a long time yet. The company has enough oil reserves to last at current production rates 2047, which is actually longer than some oil majors. Moreover, production costs are low at $35/ bbl and the company sells 93% of its oil at the Brent price, so realized prices are generally much higher and have not been affected by the US oil boom, which has pushed down WTI prices.
However, where value is being driven is in the company's cash flow and management's deployment of operating cash flow. During the second quarter, Suncor Energy Inc. (NYSE:SU) (TSE:SU) notched a cash conversion ratio of close to 100% producing a free cash flow of just under $2 billion. For the full year 2013, management are expecting to drive an operating cash flow greater than planned CAPEX spending of $7 billion. Based on historical figures, I expect free cash flow for this full year to be over slightly over $2 billion.
This is where value is being built. The strong free cash flow, coupled with three decades of reserves, guarantees free cash flows, which should only improve as oil becomes harder to find and prices rise.
Suncor's management is deploying free cash flow well, returning cash to investors by buying back stock and issuing a dividend. Since 2011, Suncor Energy Inc. (NYSE:SU) (TSE:SU) has repurchased $2.5 billion in stock, more than 5% of its issued share capital and the company just authorised another $2 billion share buyback, expected to reduce the number of shares in issue by a further 4%. Couple these buybacks with Suncor's dividend payout, which has grown at a compounded annual rate of 30% for the last five years and investors look to be well rewarded. Indeed, since the beginning of 2011, Suncor has returned $3.35 per share to investors through buybacks and dividends, which at the current stock price equates to a 10% return - these returns are unlikely to stop anytime soon.
Suncor Energy churning out cash to investors
Moreover, the company's production is expected to increase by 9% this year, further boosting cash flows and cash balances.
I should note here that the company's net debt was $7.1 billion at the end of the second quarter, cash and equivalents were worth $4.5 billion, debt interest was covered 16.6 times by cash flow and net debt was covered 0.7x by operating cash flow in the second quarter of this year alone. Currently, Suncor Energy Inc. (NYSE:SU) (TSE:SU) achieves a return on capital employed of 12.5, however, management are targeting 15% ROCE in the near term.
So overall, Suncor Energy Inc. (NYSE:SU) (TSE:SU) is a good long term value play. The company has more than three decades of production locked in, and the company is chucking out cash and returning it to investors. Furthermore, management is only spending what it can afford, strategically allocating capital to achieve the best returns. In comparison many oil majors are currently spending all of their operating cash flow from operations on CAPEX, on to see output and return on equity fall.