One of the signs that points toward Suncor Energy stock having upside is its valuation compared to itself in the past. Its current stock price ($36, or C$47) is much lower than its 2018 high of $42 (C$55). Yet oil prices are currently stronger than they were at any point in 2018. Further, there’s a decent chance that oil prices will remain strong for the foreseeable future, as I will show momentarily.
Let’s take a look at Suncor’s multiples.
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18 times adjusted earnings.
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16.9 times GAAP earnings.
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7.2 times estimated forward earnings.
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1.78 times sales.
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1.67 times book value.
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5.7 times operating cash flow.
SU appears to be undervalued based on these metrics. Yet the stock is still cheaper than it was in 2018, when oil prices were nowhere near where they are now. If the markets were correct about Suncor in 2018, then its price in 2022 should rise. The only difference between today and 2018 is that interest rates are trending higher now than they were then. 2018 was, like 2022, a period of aggressive rate hiking. The Fed hiked rates four quarters in a row that year. However, the hikes were smaller. This week the Fed hiked by 50 basis points; the 2018 rate hikes never went beyond 25 basis points. If all of these interest rate hikes lead to a much higher interest rate at the end of the year, then Suncor would deserve a cheaper stock price at the same oil price. But oil prices aren’t the same. The 2018 highfor WTI crude was $77, the 2022 high was $123. The 2022 low–$76–was just a dollar lower than the 2018 high! This extreme difference in oil prices appears to be a much bigger factor than a slight difference in interest rates. For evidence, let’s take a look at a cash flow growing at 0%, and then at 20%, with 4% as the discount rate. The 10 year treasury is currently yielding 3.05%, and the Fed has more interest rate hikes coming, so it’s reasonable to assume that the yield will level off somewhere near 4%.
| | Year 1 (1.04) | Year 2 (1.0816) | Year 3 (1.124) | Year 4 (1.169) | Year 5 (1.216) | TOTAL |
| Un-discounted cash flow (“CF”) - 0 growth | 100 | 100 | 100 | 100 | 100 | 500 |
| Discounted CF | 96.15 | 92.45 | 88.96 | 85.54 | 82.23 | 445.33 |
| Un-discounted CF - 20% growth | 100 | 120 | 144 | 172.8 | 207.36 | 744.16 |
| Discounted CF | 96.15 | 110.94 | 128.11 | 147.81 | 170.52 | 653.56 |
As you can see, the cash flow growing at 20% has a much higher present value even with 4% interest rates than the one with 0% growth. True, the faster-growing cash flow takes a higher percentage hit from the discount rate, but it’s still worth more than the one with no growth. So, rising interest rates alone do not make Suncor Energy worth less than it was in 2018. If higher oil prices translate to higher earnings, then the stock should be worth more now than it was then.
Oil Prices Could Remain High
Much of what I wrote in the previous section depends on oil prices remaining high. Not everybody thinks that they will remain high. If Suncor’s earnings don’t rise, then it does not deserve a higher stock price.
So, then, why do I think that oil prices will remain high?
It comes down to three factors:
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The war in Ukraine.
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OPEC output.
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The lockdowns in China.
The war in Ukraine has been discussed extensively in many articles on Seeking Alpha. The war has disrupted the flow of oil into Europe leading to higher prices worldwide. The war does not appear to be ending any time soon, and Europe is now considering a ban on Russian oil. All of this constricts supply, which increases prices if demand is held constant.
The second factor is OPEC output. Since the war in Ukraine began, OPEC has been reluctant to increase output. Recently it agreed to increase output a little, but it was not an accelerated hike of the sort Western countries demanded. The group agreed to increase its output by about 432,000 barrels per day in June. That’s out of about 30 million barrels per day it collectively ships. So the hike is a 1.44% increase. That’s not likely to move the needle much.
The last factor to consider is China’s COVID lockdowns. This year, China’s lockdowns have been holding back demand for oil, which has had a moderating effect on prices. Although oil is still historically expensive, it is less expensive than it would be if China were to consume its usual amount of oil. So, when China’s lockdowns end, oil prices could rise–particularly if Ukraine is still a going concern at that time.
Financial Performance
One thing Suncor Energy has going for it in 2022 is solid and rapidly improving financial performance. In its most recent quarter, Suncor delivered:
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$1.55 billion in net income, up from a $168 million loss.
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$3.14 billion in adjusted funds from operations, up 157%.
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$1.29 billion in EBIT, up from a $109 million loss.
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$2.6 billion in operating cash flow, up 225%.
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$3.7 billion in net debt reduction.
These were solid results. Not only did every single earnings metric rise enormously, but debt was reduced as well. Debt reduction is a “gift that keeps on giving,” as it reduces interest expenses and leads to higher earnings in the future. So, Suncor’s improved balance sheet will pay dividends down the line.
Speaking of Suncor’s balance sheet, here’s how it stood as of the most recent quarter:
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$10.9 billion in current assets.
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$10.4 billion in current liabilities.
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$83.7 billion in total assets.
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$47.1 billion in total liabilities.
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$36.6 billion in equity.
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$13.9 billion in long term debt.
From these numbers we get a 1.04 current ratio, and a 0.37 long term debt to equity ratio. So we’re seeing very strong liquidity and solvency–both good signs for Suncor’s long term financial health.
Risks and Challenges
As we’ve seen, Suncor Energy is a financially healthy company with a cheap valuation and a major tailwind in the form of high oil prices. It’s a winning combination. Nevertheless, there are many risks and challenges to be aware of, including:
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Regulations. The oil and gas industry is heavily regulated and sometimes entire projects are scrapped due to regulatory issues. For example, last year, the U.S. government scrapped TC Energy’s (TRP) Keystone XL pipeline. Pipelines are the most vulnerable to these kinds of issues, but all energy companies are to some extent. So, regulations could be considered a risk factor for Suncor.
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Oil prices. Suncor is more vulnerable to oil price swings than companies in certain other countries are. Saudi Arabian producers only need $10 oil to break even, Suncor needs close to $40. When oil goes too low, Suncor loses money. It ran net losses four quarters in a row in 2020 due to the low oil prices seen that year. Today, Suncor is not at risk of losing money. But it could become vulnerable in the future.
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A possible weakening of demand. In the extreme long term, Suncor could face a lessening of demand for the commodities it produces. Countries are always trying to reduce emissions, by incentivizing their citizens to buy electric vehicles. Electric cars, trains and busses are becoming more common. They probably won’t kill demand for gas powered vehicles overnight, but they could be a threat to oil over the extreme long term.