August 21, 2013

What Buffett Sees in this Oil Sands Producer

By Chad Fraser for Investing Daily

If you’re a regular Investing Daily reader, you’re likely aware that every three months we take a close look at the 13F filings of some of America’s savviest investors. Within 45 days of the end of each quarter, institutional money managers with assets of at least $100 million must report their stock holdings to the SEC via Schedule 13F.
Of course, successful investors buy and sell stocks for a wide variety of reasons, so it’s never a good idea to blindly mimic their moves. However, a timely review of these documents can make you money. Tomorrow, we’ll take our regular quarterly look at the latest 13F filings from some of America’s leading investors to see what we can learn from them—and how you can profit.
Today, however, we’re going to zero in on one transaction that could have significant implications for the North American energy sector: Warren Buffett’s purchase of 17.8 million shares of Canadian oil sands giant Suncor Energy (NYSE: SU, TSX: SU).
Buffett’s purchase, revealed in Berkshire Hathaway’s (NYSE: BRK.A, BRK.B) second quarter 13F filing, amounts to about $595 million at today’s prices, or about 1.2% of Suncor’s $50.7-billion market cap. Analysts interviewed by Canada’s Globe and Mail newspaper couldn’t recall a previous occasion in which the Oracle of Omaha had invested in a company based north of the border.
 “If it’s not the first time, it’s definitely the largest stake he’s ever taken in a Canadian company,” said Barry Schwartz, a vice-president at Toronto’s Baskin Financial Services.
Suncor: An Oil Sands Pioneer
Suncor is Canada’s largest oil producer. In 2012, the company averaged 549,100 barrels of oil equivalent per day (boe/d) of output. The Alberta oil sands accounted for 359,200 boe/d, or 65% of that total.
The company’s history in the oil sands stretches back to 1967, which, coincidentally, was Canada’s centennial year. Back then, it was known as Sun Oil. It began operating under the Suncor name in 1979, after amalgamating with Great Canadian Oil Sands.
Suncor extracts from the oil sands near Fort McMurray, Alberta, using mining (heavy trucks, shovels and other equipment), as well as in situ production, which resembles conventional oil production, to reach areas that are too deep to mine.
The company has entered into a number of joint ventures. For example, it owns a 12% stake in the Syncrude oil sands operation, as well as a 40.8% interest in the development-stage Fort Hills project. France’s Total SA (NYSE: TOT) and Teck Resources (NYSE: TCK, TSX: TCK.B) own the remainder of Fort Hills.
The partners will likely make a decision on whether to go ahead with Fort Hills, which is estimated to contain 3.4 billion barrels of bitumen, later this year. In addition, Suncor holds 36.75% of the Joslyn mining project (operated by Total), which is expected to produce 100,000 barrels per day (bpd), though Joslyn’s start-up has been delayed at least to 2021 or 2022.
Suncor also operates the McKay River and Firebag in situ projects, which use steam assisted gravity drainage (SAGD). This process involves injecting steam into the well, which makes it easier to pump the bitumen to the surface. The company is currently ramping up Firebag’s fourth stage, which will boost the project’s capacity to 180,000 bpd.
It also has conventional operations in the North Sea and elsewhere around the world. Management’s statedgoal is to boost the company’s output to one million boe/d.
In addition to its producing assets, Suncor operates four refineries and 1,500 gas stations.
Rebounding From a Disappointing Quarter
The company’s second quarter earnings, which it reported July 31, disappointed investors; during the period, it reported operating profits of C$934 million, or C$0.62 a share, down from C$1.25 billion, or C$0.80, a year ago. ($1 Canadian = $0.97 U.S.) The latest earnings missed the consensus forecast by C$0.01. Cash flow per share declined to C$1.49 from C$1.51.
The lower earnings and cash flow were largely due to a decline in Suncor’s production, to 500,100 boe/d from 542,200 boe/d a year ago. Oil sands output declined to 276,600 bpd from 309,200, due to a number of one-time issues, including planned maintenance at one of its upgraders (which converts oil sands bitumen to synthetic crude), and a pipeline shutdown caused by flooding in Alberta.
These setbacks have now been addressed. ‘‘Following these events, production at our oil sands operations has been restored, and we are currently seeing strong performance,” said Suncor president and CEO Steve Williams.
As if to emphasize the point, on August 1, the company said that its July oil sands production likely hit 390,000 barrels per day—a new record.
“[Suncor has] been one of our more favored names over the last while, and a big part of our thesis was that operations are set to improve significantly. We felt that maybe the market wasn’t going to believe it until it saw it,” said Michael Dunn, vice-president of institutional research at First Energy Capital Corp., in an August 13Financial Post article. “Now we have seen some of the first evidence with the July results.”
Shares Have Been Stuck in Neutral
The stock has made little progress in the past three years, as oil sands producers have dealt with a lack of pipeline capacity in Western Canada, which has forced them to ship more crude by rail—a more expensive option. Oil sands stocks have also suffered due to a rise in production of shale oil in the U.S.
As a result of these factors, prices for Western Canadian heavy oil and synthetic crude have sold at a larger-than-normal discount to benchmark U.S. West Texas Intermediate, further hurting oil sands producers’ profits.
The current environment called into question the economics of Suncor and Total’s planned $11.6-billion Voyageur bitumen upgrader project. Earlier this year, the partners decided to cancel Voyageur after Suncor had already taken a $1.49-billion writedown on it in the fourth quarter of 2012, plus an additional $127 million in Q1 2013.
However, Suncor has gained ground in the past few weeks. In addition to the strong production report from July, TransCanada Corp. (NYSE: TRP) has announced its plan to develop the Energy East pipeline, which would pump oil sands crude to refineries on Canada’s east coast.
“A Phenomenal Investment Opportunity”
Which brings us back to Mr. Buffett, whose move most analysts felt came back to value.
“Suncor is one of the most heavily undervalued Canadian integrated oil producers,” said Morningstar analyst David McColl in an August 15 Reuters article. “It is no surprise that a value investor like Berkshire Hathaway would see it as a phenomenal investment opportunity.”
Buffett may also have strategic interests at heart, as the purchase could help him further profit from the oil-by-rail boom, particularly if the Obama administration nixes the Keystone XL pipeline: Berkshire also owns Burlington Northern Santa Fe Railway, which expects to boost its crude shipments by 40%, to 700,000 barrels per day, by the end of 2013.
The company’s ongoing buybacks and dividend increases also add appeal. In April, it hiked its quarterly dividend by 54%, to $0.20 a share from $0.13. The stock now yields 2.3%.
In the latest quarter, Suncor repurchased $294 million of its own stock. The company may now repurchase up to $1.8 billion of its shares between August 5, 2013, and August 4, 2014. In the 12 months ended July 29, Suncor bought back $1.3 billion worth of shares at an average price of $31.67 each.
It’s a move that Buffett likely approves of: “Indeed, disciplined repurchases are the surest way to use funds intelligently,” he wrote in his latest letter to Berkshire shareholders. “It’s hard to go wrong when you’re buying dollar bills for $0.80 or less … But never forget: in repurchase decisions, price is all-important. Value is destroyed when purchases are made above intrinsic value.”
Courtesy Chad Fraser for Investing Daily

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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