Suncor Energy (OP/A): Continue to recommend as core long-term oil-levered holding - Goldman Sachs - May 05, 2006
We continue to view Suncor Energy (OP/A) as a core long-term investment that can benefit from higher WTI prices while achieving organic oil production growth at attractive rates of return. Most oil-focused E&Ps and integrateds have performed quite well year to date and are trading relatively close to traditional peak values. Nevertheless, crude prices in the upper $60- to low $70- range are not being reflected in consensus2006 and 2007 estimates. Suncor, in particular, is the model oil sands company that has mining expansion potential, in-situ expansion potential and a track record of operational success. While capital and operating costs continue to rise, we view these pressures as highly cyclical and have confidence that Suncor will maintain a cost advantage versus its peers.
KEY COMPANY-SPECIFIC CATALYSTS
(1) Timing and cost of expansion projects. Suncor is currently on schedule and on budget with its Millennium Coker project that should take upgrading capacity to 350,000 bpd from 260,000 bpd at present. Suncor has bucked the trend of cost overruns and delays seen by other operators historically and seems more confident that there will not be any major issues for this coker, expected to startup in 2008. The company is seeing cost overruns in its expansion/upgrading of the Denver refinery, attributed to a less mature, less flexible construction labor market in Denver versus Ft. McMurray. With these projects now defined, the focus begins to shift to the 150,000-200,000 bpd Voyageur expansion planned for 2010-12. We are currently building in costs of about C$55,000 per bpd of capacity, though cost pressures could push that higher. We expect greater details on plans and expected cost over the next year, with the first catalyst this summer with a regulatory hearing on the project. In addition, management indicated it could provide more details on a post-Voyageur expansion during 1H 2007.
(2) Operating cost pressures. Increasing cost inflation has caused a spike in operating costs over the last year, the result of the stronger Canadian dollar versus the US dollar, higher steel costs, higher natural gas prices (which more recently have decreased benefiting oil sands returns) and higher labor costs. We have increased our oil sands operating cost estimates to account for more than just the reclassification of overburden removal as an income statement expense. Operating costs per net barrel (13.5% royalty rate) were about US$23 per BOE. However, we continue to believe much of this is cyclical and that, in the event of a decline in commodity prices to mid-cycle levels, the Canadian dollar would weaken, labor costs would fall, natural gas costs would fall and steel costs would fall. Thus, our mid-cycle cost estimates are unchanged. We believe concerns regarding oil sands costs remain overdone and do not fully take into account the cyclical drivers of higher costs relative to both cyclical and secular drivers of higher costs elsewhere in the world.
(3) Street confidence in in-situ oil sands production versus mining projects. One of the most significant areas of upside for Suncor in our view could come from a revaluation of in-situ oil sands resource. Oil sands mining projects continue to be valued higher in our view than in-situ projects, in part because technology is more mature, in part because the resource is "visible," in part because production rates are more consistent and in part because projects are more scalable. Much of Suncor's 14 billion BOE of recoverable oil sands resource is seemingly too deep to mine, meaning that greater confidence in technologies such as steam-assisted gravity drainage (SAGD) can increase the valuation of this resource. We believe production from SAGD projects industrywide is becoming more consistent and would note that Suncor has seen production increase and steam-oil ratios decrease at Firebag, a very positive sign. Over time, we believe the Street will become more confident in SAGD and in-situ overall, which should benefit Suncor and EnCana (OP/A) the most.
1Q 2006 RESULTS MIXED
Suncor reported mixed 1Q 2006 operating and financial results. Higher than expected insurance proceeds led to EPS and cash flow above our estimates, with adjusted EPS of $1.39 versus our estimate of $1.08 and operating cash flow of $1.16 billion versus our estimate of $924 million. Net oil sands production of 228.9 Mb/d was slightly below our estimate of 234.9 Mb/d, while the average realized oil sands price was $56.91 per barrel, in line with our estimate. Costs were above expectations, with oil sands operating costs rising to $22.90 per barrel versus our estimate of $16.68 per barrel. Total refining EBITDA was $44 million, below our estimate of $76 million.
UPDATING ESTIMATES
We are lowering our quarterly 2006 and full-year 2006-2010 EPS estimates mostly to reflect higher estimated costs, in addition to minor other adjustments. Our 2Q, 3Q, and 4Q 2006 EPS estimates are now $0.88, $1.04, and $1.20 versus $1.07, $1.23, and $1.04 before, respectively. Our full-year 2006 EPS estimate is now $4.51 versus $4.66 before. Our 2007 EPS estimate is now $4.12 versus $4.34 before. Our 2008-2010 (normalized) EPS estimates are now $1.77, $1.69, and $3.02 versus $1.79, $1.72, and $3.05 before, respectively.
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. |
