Key Risks
The increasing likelihood of lower for longer oil prices is the main risk impacting practically every energy company today. The Organization of Petroleum Exporting Countries (OPEC), which supplies around 40% of the world’s oil today, effectively abandoned their production limits in December 2015. These countries are intent on crushing new U.S. shale oil players in an effort to take back market share, even if it comes at a significant near-term price.
Fears of slowing global growth are only adding to the carnage in oil prices.
With global oil prices quickly approaching an unthinkable $30 per barrel, many energy companies won’t survive if such conditions persist.
SU shouldn’t be one of them due to its low-cost operations, strong cash flow generation, and investment-grade balance sheet.
We suppose that SU’s risk is making an “opportunistic” acquisition that backfires (e.g. buys a higher-cost producer, only to realize it is unable to take as much cost out as expected), reducing the company’s financial strength as macro conditions remain depressed.
It oil sands production is also more costly than conventional oil production because of its energy-intensive production methods. However, SU’s E&P and refining & marketing segments and extensive logistical network help diversify its cash flow. In its 2014 annual report, SU noted that it was able to capture global-based pricing on volumes equivalent to 97% of its upstream production, mitigating some of the risk associated with being an oil sands producer during periods of low oil prices.
Overall, SU looks like one of the best houses in a bad neighborhood. The company has the financial strength to buy up some of its neighbors for potentially $0.60 on the dollar, but it’s a bet on management to feel comfortable about this opportunistic risk.
Dividend Analysis
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. SU’s long-term dividend and fundamental data charts can all be seen by clicking here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
SU’s dividend has a Safety Score of 43, which is close to average but better than about 90% of all other dividend-paying energy companies in our database.
Through the first nine months of 2015, SU paid dividends of Cdn$1.23 billion. Over that same time period, the company generated Cdn$875 million of free cash flow – not enough to cover the dividend at first glance. However, this figure included a whopping Cdn$2.7 billion of growth capital spending, which is ultimately discretionary in nature if things ever got really bad.
If SU cut all growth capex, it would have generated about Cdn$3.6 billion of free cash flow compared to its dividends paid of Cdn$1.23 billion – nearly 3x coverage. Additionally, SU has Cdn$5.4 billion in cash and undrawn lines of credit of Cdn$6.9 billion. The company also maintains an investment-grade credit rating with S&P (although it will be reviewed if it acquires Canadian Oil Sands).
Its consistent free cash flow generation (see below), growing production base, integrated business model, and strong balance sheet are allowing it to continue paying the dividend while pursuing opportunistic acquisitions.
Source: Simply Safe Dividends
Most oil companies are scrambling enough just to find ways to continue paying their dividends, much less think about growth.
We can also see the quality of SU’s resource base, operational excellence, and capital discipline reflected in its return on invested capital metric, which has remained positive and relatively stable for a commodity company:
Source: Simply Safe Dividends
Before oil prices collapsed during the second half of 2014, we can see that SU’s long-term earnings payout ratio was around 30%. For a cyclical, commodity-sensitive business, this was a safe level heading into the crash, especially considering SU’s free cash flow generation and balance sheet.
Source: Simply Safe Dividends
With operating costs continuing to come down, production set to predictably rise over the next 5-10+ years with projects such as Fort Hills, and flexibility with growth capex, we believe SU’s dividend will remain safe even in a much “lower for longer” oil environment.
