Suncor Energy (OP/A): Beyond fire, valuation remains attractive Goldman Sachs April 28, 2005
Suncor Energy?s first quarter was, as expected, marred by higher costs and lower earnings due to the fire at its upgrader. We believe that aside from slightly higher costs from Suncor's Firebag in-situ oil sands operation, it is difficult to discriminate between fire-impacted higher oil sands mining costs and those that are sustainable. We expect a similar lack of clarity in coming quarters and believe that until next year Suncor?s quarterly results will not be a reliable indicator of the state of the oil sands business. We continue to believe that Suncor can continue to achieve higher full-cycle returns versus other domestic oils and believe that despite Suncor's premium multiple, valuation does not reflect the company's 9% secular volume growth. We rate Suncor Outperform relative an Attractive coverage view.
KEY UPCOMING CATALYSTS
(1) Upgrader restart and timing of insurance payments. In the near term, we believe that the Street's main concern will be how soon Suncor can restart its upgrader and how soon the company will be compensated for business interruption. We currently estimate the remaining insurance payments should total about $800 million before taxes and after royalties. However, it is difficult to determine what percent of the higher oil sands costs during the first quarter were due to the fire and what could be due to general trends/margins. We have further decreased our 2005 estimates and increased our 2006 estimates reflecting a slower startup time and higher costs during 1Q 2005. Overall, we believe the fire and the focus on timing of insurance payments has created an opportunity as the stock has not outperformed other domestic oils. We believe that in a refining/upgrading business one strike is allowed, and Suncor has not had a disproportionate amount of accidents in our view.
(2) Firebag reliability/returns. Although Suncor's in-situ Firebag oil sands unit represents about 10% of its oil sands capacity, we believe the Street will continue to focus on profitability given that much of the 2008 expansion to take production capacity from 260,000 barrels of oil equivalent (BOE) per day to 350,000 BOE/d is expected to come from in-situ. Gas consumption and overall costs continue to fluctuate and remain at higher-than-normal levels. We believe there is already Street concern regarding in-situ costs and therefore see an opportunity for Suncor shares if the company can deliver more lower and more consistent costs at Firebag over time.
(3) Street confidence in oil sands as a sustainable business model. We continue to believe that the Street is overly concerned with oil sands cost inflation and is not appropriately valuing Suncor's 9% secular growth rate. The major reasons for rising oil sands costs - higher steel prices, rising labor costs and a stronger Canadian dollar - are all cyclical in nature and have the potential to correct over time, especially in a lower commodity price environment. In contrast, much of the rising cost for conventional producers has been secular - rising finding and development costs due thus far more to mature North American and North Sea resource bases versus higher service costs. Thus, we believe that we see greater potential for costs to fall for oil sands at lower commodity prices than for conventional producers. While Suncor trades at a premium valuation, we see further multiple expansion to a US$50 per share traditional peak value which we believe would reflect the combination of the company's growth, resource base and returns.
1Q 2005 PRODUCTION, CASH FLOW IN-LINE WITH OUR EXPECTATIONS
Suncor reported 1Q 2005 operating and financial results generally in line with expectations. Reported EPS of $0.17 was below our estimate of $0.23, reflecting in-line production and strong price realizations more than offset by higher than expected unit costs. Operating cash flow of $240 million was in line with our estimate of $245 million. Costs were higher than expected. Operating costs in oil sands were $19.70 per net barrel of oil equivalent, higher than our $13.74 per BOE estimate. This reflected three factors:
(1) greater natural gas consumption due to lower-than-expected efficiency both at Firebag and in mining;
(2) higher natural gas prices than expected due to greater levels of purchased natural gas; and
(3) higher per-unit non-gas costs, which we attribute mostly to the fire. Lease operating expense from conventional production was lower than expected. Net oil sands production of 122.3 MB/d was in-line with our estimate of 120.9 MB/d. Price realizations of $37.88 per barrel for oil sands output and $5.55 per Mcf for natural gas were above our estimates of $37.34 per barrel and $5.07 per Mcf, respectively. Total downstream EBITDA of $13 million was in-line with our estimate of $14 million, though due to higher than expected refining volumes of 63.5 MBOE/d offset by weaker than expected refining margins of $7.42 per BOE versus our estimate of $9.00 per BOE. Net debt/tangible capital was 33% at quarter-end.
UPDATING ESTIMATES
We have updated our EPS estimates to incorporate changes to our assumptions for production and unit costs. We now estimate EPS of $0.19 for 2Q 2005 ($0.23 previously), $0.25 for 2Q 2005 ($0.32 previously), $0.62 for 4Q 2005 ($0.61 previously), and $1.24 for full-year 2005 ($1.39 previously). Our 2006 EPS estimate is now $4.50 versus $4.43 previously. There are no changes to our 2007-2010 (normalized) EPS estimates.
Each of the analysts named below hereby certifies that, with respect to each subject company and its securities for which the analyst is responsible in this report, (1) all of the views expressed in this report accurately reflect his or her personal views about the subject companies and securities, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report: Brian Singer, Arjun Murti. |
