suncor petro-canadaLARRY MACDOUGAL
When Suncor Energy Inc. announced plans to acquire Petro-Canada in March of 2009, North America was in the midst of a recession and oil prices had fallen to $50 (U.S.) a barrel. Over 85 per cent of Suncor's production came from the high cost oil sands in Alberta at the time, so chief executive Rick George acted to diversify the company and ensure financing was available for projects caught in the squeeze of a credit crisis.
Finalized on Aug. 1, 2009, the merger created Canada's largest integrated oil company. Petro-Canada brought production weighted 55 per cent toward conventional oil sources to the table, in addition to its oil-sands properties, refineries and 1,300 gas stations.
As of early 2011, market cap for the Calgary-headquartered entity stood at $58.3-billion, fourth largest on the Toronto Stock Exchange.
Suncor still focused on oil sands
Reaction to the merger announcement in 2009 was somewhat subdued. The market appeared to be assuming Suncor's growth would slow to the rates of its integrated peers, as its asset base diversified away from the fast-growing oil sands, noted Stephen Richardson, the Morgan Stanley analyst who is one of the best at forecasting Suncor's earnings according to the Thomson Reuters StarMine survey.
But Mr. Richardson said Suncor instead is actually keeping its focus on the oil sands through divesting gas and non-core assets and directing the proceeds toward projects with the best risk-adjusted returns in the bitumen business. The company is also supporting projects with annual funding of over a billion dollars from operating and capital-expenditure synergies, plus ongoing free cash flow generated by the retained assets of Petro-Canada.
Management has realized synergies by more than twice original estimates. Sales of natural-gas assets worth $2-billion to $3-billion are going forward, as are sales of non-core assets in the North Sea - at prices better than expected. In addition, Petro-Canada's international headquarters in London is being cut back.
Meanwhile, Suncor is looking into capturing cost savings through contracting out supply-chain management, information technology and other services. Purchasing and other functions are being harmonized or centralized. The pre-merger headcount of 12,850 is on course to be reduced by approximately 2,000 people (with most going along with the assets sold to other companies).
Shares range bound
Yet, the company's shares have largely remained range bound between $32 and $38, and have lagged price gains in crude oil and peers' shares. Doubts seem to have lingered over Suncor's ability to integrate Petro-Canada. The fires in early 2010 at the upgraders north of Fort Murray may have additionally fuelled suspicions that the magnitude of the merger caused executives to take their eye off operations.
"The Suncor story has been in a state of flux," noted Andrew Potter, an energy analyst with CIBC World Markets Inc. in a recent report on Suncor. "A number of events and issues such as operational reliability, ongoing asset sales, and the Petro-Canada merger have made it difficult for the Street to fully comprehend the intended direction and future composition of the company."
Perking up lately
Suncor's shares recently began to probe the upper boundary of its trading range. One positive was better-than-expected production figures in the third quarter, according to another top-rated analyst in the StarMine rankings, TD Newcrest's Menno Hulshof. A second positive was the company's downward revision to cash operating costs in the oil sands to the range of $38 to $40 per barrel.
Third-quarter results may have marked "the beginning of a new chapter," declared Mr. Hulshof in a report issued just after the earnings release. He maintained a "buy" recommendation and hiked his target price to $45 from $43.
In an early December report, Mr. Richardson saw a new chapter, as well. He anticipated Suncor's Dec. 17 presentation on strategic initiatives and 2011 guidance would likely result in the clearing up of uncertainties over capital spending and the growth trajectory of oil-sands production. "This disclosure should … likely act as a catalyst for the shares to play catch up versus oil-levered peers," he concluded.
The Dec. 17 strategy and 2011 outlook update didn't disappoint. Of note, management projected a compound annual growth rate (CAGR) of 13 per cent to 2014, and 8 per cent to 2020 - "impressive," observed Mr. Potter.
Mr. Richardson liked the re-ordering of Suncor's backlog and the new partnership with Total S.A., both of which prioritized better paying mining projects ahead of steam assisted gravity drainage (SAGD) projects. He consequently increased his estimated value of Suncor's shares by $2 to $46, but after "allowing for increased cost inflation," maintained his $44 per share price target.
BMO Capital Markets analyst Randy Ollenberger is of the view "that Suncor can develop Petro-Canada's oil sands portfolio efficiently." But he suggests long-term growth will be lower than management's guidance. "Oil sands production should grow very strongly. However, we expect natural-gas production to decline, which drops the compound annual growth rate to around 5 per cent."
Mr. Potter is in the bullish camp. In his Dec. 19 report, he maintained his "outperformer" rating and increased his price target to $45 from $43. "As investors see improved reliability and the start of free cash flow, we expect the stock's valuation to re-rate substantially," he added.