March 11, 2015 Suncor Energy (SU-NYSE) Current Recommendation Prior Recommendation Neutral Date of Last Change 12/18/2014 Current Price (03/10/15) $28.03 Target Price $25.00 UNDERPERFORM SUMMARY Amid weak crude pricing environment, we are maintaining our Underperform recommendation on Suncor Energy. The plunging oil price since Aug 2014 has been affecting Suncor s upstream operations. On top of that, we don t foresee any immediate oil price recovery. Post Petro-Canada acquisition, we are also worried about Suncor s elevated debt level and significant anticipated capital expenditure requirements. Moreover, the operational and project execution risks will keep the stock under pressure in the coming months. Owing to these factors, we see the company as a risky bet that investors should exit. SUMMARY DATA 52-Week High $43.17 52-Week Low $26.90 One-Year Return (%) -11.35 Beta 1.63 Average Daily Volume (sh) 3,152,474 Shares Outstanding (mil) 1,445 Market Capitalization ($mil) $40,505 Short Interest Ratio (days) 1.58 Institutional Ownership (%) 61 Insider Ownership (%) 1 Annual Cash Dividend $0.90 Dividend Yield (%) 3.21 5-Yr. Historical Growth Rates Sales (%) 3.8 Earnings Per Share (%) 24.7 Dividend (%) 24.8 using TTM EPS 9.7 using 2015 Estimate 71.9 using 2016 Estimate 28.9 Zacks Rank *: Short Term 1 3 months outlook 4 - Sell * Definition / Disclosure on last page Risk Level * Average, Type of Stock Large-Value Industry Oil-C$ Integrtd Zacks Industry Rank * 244 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 9,840 A 9,493 A 9,980 A 9,710 A 39,023 A 2014 9,510 A 9,760 A 9,440 A 8,000 A 36,710 A 2015 6,725 E 6,767 E 6,010 E 4,314 E 23,816 E 2016 28,988 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.90 A $0.62 A $0.91 A $0.63 A $3.06 A 2014 $1.11 A $0.71 A $0.82 A $0.24 A $2.88 A 2015 $0.11 E $0.09 E $0.06 E $0.13 E $0.39 E 2016 $0.97 E Projected EPS Growth - Next 5 Years % 10 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Calgary, Alberta-based Suncor Energy, Inc. (SU) is Canada s premier integrated energy company. Suncor's operations include oil sands development and upgrading, conventional and offshore crude oil and gas production, petroleum refining, and product marketing under the Petro-Canada brand. Following the Petro-Canada acquisition in 2009, Suncor has become one of the largest owners of oil sands in the world. The company has gained new oil sands properties to supplement its existing operations in northern Alberta, making it the dominant producer in the region where reserves are second only to Saudi Arabia. Additionally, Suncor explores, acquires, develops, produces and markets crude oil and natural gas in Canada and internationally, and it transports and refines crude oil and market petroleum and petrochemical products primarily in Canada. Occasionally, Suncor also sells third-party petroleum products. The company carries out energy trading activities focused principally on buying and selling futures contracts and other derivative instruments based on the commodities it produce. Suncor s business can be divided into four segments: Oil Sands, Exploration and Production (E&P), Refining and Marketing, and Corporate, Energy Trading and Eliminations. Oil Sands: Suncor s Oil Sands segment mines and upgrades oil sands in Canada s Alberta province, to produce refinery-ready synthetic crude oil. In addition, the company has a 12.0% ownership interest in the Syncrude oil sands mining and upgrading joint venture, also located near Fort McMurray, Alberta. Production from this segment during 2014 averaged 421.9 thousand of barrels per day. Exploration and Production: This unit includes offshore operations off the east coast of Canada and in the North Sea, and onshore operations in North America, Libya and Syria. In particular, Suncor has a strong position in every major producing oil development off Canada's east coast, including Hibernia, White Rose, Terra Nova, and Hebron. Refining and Marketing: Suncor s Refining and Marketing segment operates refineries in Edmonton, Alberta, Montreal, Quebec, Sarnia, Ontario and Commerce City, Colorado with a total capacity of 462,000 barrels per day, as well as a lubricants plant that is the largest producer of lubricant-base stocks in Canada. In addition, the unit markets refined products to retail, commercial and industrial customers mainly in Canada and Colorado through a combination of company-owned, brandeddealer and joint venture-operated retail stations, a large Canadian national commercial road transport network and a robust bulk sales channel. Other assets include interests in pipelines and product terminals in Canada and the U.S. Corporate, Energy Trading and Eliminations: This segment includes the company s investment in renewable energy projects, results associated with third-party energy supply and trading activities and other activities not directly attributable to other operating segments. Equity Research SU Page 2
REASONS TO SELL Suncor Energy s major focus is on the production of crude from the Alberta oil sands. This is a highrisk strategy considering the higher costs associated with the extraction of oil from the oil sands compared to production from conventional oil wells. Crude price has been showing weakness since Aug 2014. Moreover, we don t expect any immediate spike in oil price in the coming months with the commodity being over supplied in the face of lackluster global demand. These are expected to considerably hamper Suncor s upstream businesses as it will not be able to generate sufficient cash flows after selling crude at low prices. Suncor s deep oil sands technology, though proven, is still vulnerable to potential delays, in our view. In particular, there are risks related to growth and other capital projects that depend wholly or partly on new technologies. The success of these projects remains uncertain. Additionally, the process of extracting crude from oil sand reserves is more expensive than conventional production. After the Petro-Canada acquisition, we remain worried about Suncor s high debt level (C$12.5 billion) and significant anticipated capital expenditure requirements (C$6.2 C$6.8 billion in 2015). This is expected to substantially increase Suncor s leverage and deteriorate its credit metrics. Additionally, the increasing capital intensity of its operations may result in reduced returns going forward. RISKS Suncor has significant oil sands and a conventional production platform, huge long-lived oil-sands reserves and an impressive downstream portfolio. The company s asset base includes substantial conventional reserves and production at offshore Eastern Canada and in the North Sea, which is capable of generating strong margins and free cash flows. Success on this front may affect our recommendation. As is the case with other exploration and production companies, Suncor s results are directly exposed to oil and gas prices, which are inherently volatile and subject to complex market forces. Realized prices could differ significantly from our estimates, thereby affecting the company s revenues, earnings and cash flows. With an aim to weather low commodity prices, Suncor is planning to cut its expenses significantly. Over the coming two years, the company will likely reduce its operating cost by C$600 C$800 million. Hence, Suncor s shares could outperform our target price. Equity Research SU Page 3
RECENT NEWS Fourth Quarter 2014 Results On Feb 4, 2015, Suncor Energy reported fourth-quarter 2014 operating earnings per share of C$0.27 (US$0.24). The earnings reported were not only substantially below the Zacks Consensus Estimate of US$0.45 but also were lower than the year-ago quarter level of C$0.66. Lower production levels and weak crude pricing environment hampered the results. In the reported quarter, total revenue was C$9.09 billion (US$8 billion) compared with C$10.19 billion in the year-ago quarter. The top line also failed to meet the Zacks Consensus Estimate of US$9.9 billion. Quarterly operating earnings of C$386 million were significantly lower than C$973 million recorded a year ago. Moreover, cash flow from operations decreased to C$1.5 billion from C$2.4 billion in the fourth quarter of 2013. Production Total upstream production in the reported quarter averaged 557,600 barrels of oil equivalent per day (BOE/d), marginally lower than the fourth-quarter 2013 level of 558,100 BOE/d. Higher maintenance activities in the Oil Sands segment were partially offset by increased contribution from the Exploration and Production segment. Oil sands volume was 384,200 barrels per day (Bbl/d), lower than 409,600 Bbl/d recorded in the year-ago quarter. Unplanned maintenance activities hampered the volume. Production from Syncrude operations decreased about 5% year over year to 35,100 Bbl/d in the quarter as a result of unplanned maintenance activities. Suncor s Exploration and Production segment (consisting of International and Offshore and Natural Gas segments) produced 138,300 BOE/d, higher than 111,600 BOE/d in the prior-year quarter. Contribution from Libya and increased production at Terra Nova aided the result. The Refining and Marketing segment averaged 440,800 Bbls/d of refinery crude processed, up from 419,000 Bbls/d in the year-ago quarter. The refinery utilization came in at 95%, higher than the year-ago quarter level of 91%. Product Sales The company s refined product sales of 548,200 Bbls/d increased 3.8% from the prior-year quarter. Operating Expenses Suncor reported operating cost of C$2.3 billion compared with C$2.5 billion in the year-ago quarter. Balance Sheet & Capital Expenditure As of Dec 31, 2014, Suncor had cash and cash equivalents of C$5.5 billion and total long-term debt (including current portions) of C$12.5 billion. The debt-to-capitalization ratio was approximately 23%. Moreover, the company incurred capital expenditure of C$1.9 billion in the quarter. Equity Research SU Page 4
2015 Guidance Suncor lowered 2015 capital spending projection by C$1 billion to C$6.2 C$6.8 billion to deal with low crude pricing. The company also plans to reduce operating expenses by C$600 C$800 million over the next two years. VALUATION Crude price has been plummeting since last July. Hence, we don t expect Suncor to generate sufficient cash flows from its upstream business amid the weak crude pricing scenario. We also remain concerned about the company s high debt level and capital expenditure requirements. These are reflected in our retained Underperform recommendation on the stock. Suncor s trailing 12-month P/CF multiple is 4.5, compared to the 6.0 average for the peer group and 14.6 for the S&P 500. The company s trailing 12-month EV/EBITDA multiple is 4.3, compared to the industry average of 48.0. Our $25 price objective reflects a multiple of 4.0X trailing twelve-month cash flow. Equity Research SU Page 5
Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Suncor Energy Inc. (SU) 71.9 28.9 10.0 4.5 9.7 52.6 8.1 Industry Average 42.7 48.0 6.2 6.0 13.1 219.1 19.0 S&P 500 16.5 15.4 10.7 14.6 18.2 18.4 12.0 Imperial Oil Ltd. (IMO) 41.9 23.0 8.6 9.3 21.4 9.3 Ecopetrol S.A. - ADR (EC) 12.3 7.5 6.0 4.5 7.1 26.7 7.5 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Suncor Energy Inc. (SU) 1.2 2.0 1.1 10.8 0.3 3.2 4.3 Industry Average 1.4 1.4 1.4 8.3 0.3 4.8 48.0 S&P 500 6.2 9.8 3.2 25.4 2.0 Equity Research SU Page 6
Earnings Surprise and Estimate Revision History Equity Research SU Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of SU. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1129 companies covered: Outperform - 15.5%, Neutral - 74.8%, Underperform 8.9%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Analyst Editor QCA Lead Analyst Reasons for Update Nilanjan Banerjee Sudipta Mukherjee Nilanjan Choudhury Nilanjan Choudhury Earnings Update Equity Research SU Page 8