(Public) Suncor Energy - Management Execution Is Increasing Value Per Share

When Suncor Energy (SU:CA) CEO Rich Kruger assumed the job one year ago, he clearly laid out what he planned to accomplish. Since then, the company has hit one goal after the next. It divested its U.K. wind and solar business, expanded its ownership of the massive Fort Hills bitumen operation, achieved record high companywide production volumes, increased downstream asset utilization to record levels, and improved its safety performance. These accomplishments are changing the market’s perception of Suncor from a perennial laggard to a serial outperformer, with positive implications for its share price.

Yesterday, Suncor's management hosted a business update conference call in which it discussed its objectives through 2026. Its guidance sent Suncor shares up 3% on a day when E&Ps struggled to stay flat. Despite yesterday's boost in the share price, we see significant additional gains if management can execute on the goals outlined in its call.

We purchased our Suncor position for our income portfolio on August 18, 2024, at C$43.95 under the Canadian ticker. We did so under the expectation that the shares’ 5.0% dividend yield at the time was set to increase as the company hit its net debt target and boosted the percentage of free cash flow paid out to shareholders.

Yesterday's business update increased our conviction in the long-term prospects for Suncor's growth in free cash flow and intrinsic value per share. Moreover, the sustainable improvements we expect in Suncor's margins and return on capital prompted an increase in our intrinsic value estimate for the shares. We now see the prospect of 32% upside at $87.50 per barrel WTI, and we expect the appreciation to be accompanied by higher dividends.

Management’s Goals to 2026

In yesterday’s call, management surprised the market by guiding to a whopping C$10 per barrel reduction in Suncor’s breakeven WTI price, doubling its previous guidance. Such an improvement would increase cash flow per share by multiple billions of dollars down to $70 per barrel WTI.

Half the improvement is expected to come from the upstream segment, as shown below.

Source: Suncor Energy, Business Update Webcast Presentation, May 21, 2024.

The upstream improvement is in large part due to the 100,000 boe/d of production growth management expects to achieve through 2026. This would grow Suncor’s production from 750,000 boe/d when Kruger took over one year ago to 850,000 boe/d in 2026.

Such growth typically comes with higher costs, but Suncor intends to reduce costs as revenues rise. Cost savings will be realized in the company’s mining truck fleet, maintenance expenditures, and in-situ bitumen operations.

Management expects higher top-line growth and lower costs to increase free funds flow—a proxy for free cash flow—by C$3.3 billion in 2026, equivalent to C$2.75 per share at $75 per barrel WTI.

Source: Suncor Energy, Business Update Webcast Presentation, May 21, 2024.

Improvements are also underway in the downstream segment. Management is also seeking to maximize the benefits from Suncor's vertical integration that stretches up and down the oil value chain. The result will be top-line growth and cost savings that further enhance margins and cash flow generation. Suncor plans to boost downstream margins further from more efficient refinery turnarounds, greater refinery uptime, higher utilization, and new power generation initiatives.

Free funds flow will be driven still higher over the next few years from lower capex. Management guided for capex to fall from slightly above C$6 billion in 2024 to the mid-C$5 billion range by 2026.

This is welcome news for shareholders in the near term, though we doubt it will be sustainable far beyond 2026, given the spending increases likely to occur from debottlenecking necessary to replace bitumen from Suncor’s depleting Base Mine.

All these margin improvements and capex reductions will enhance Suncor’s operating leverage and cash flow torque to oil prices. To the extent they’re executed, they will increase free cash flow per share above our previous expectations, thereby increasing the implied returns on offer at the current stock price.

Positive Surprises for Capital Allocation

Management offered another surprise by bringing forward the timing of its pivot to 100% free cash flow payout to shareholders. Formerly, it planned to pay out 75% of free cash flow when its year-end 2023 net debt balance fell by an additional C$1.5 billion. It now intends to distribute 100% of free cash flow when it reaches that point.

Another positive change is that management now intends to favor share repurchases over dividends. Its goal is to maximize total returns, not only income or capital appreciation. As long as Suncor shares trade at a discount, it believes share repurchases remain the most effective way to increase value on a per-share basis.

We agree. In the long term, income investors will also benefit from repurchases, as dividend payout potential increases on a per-share basis with a falling share count.

Management’s official guidance calls for its debt target to be hit next year, but CEO Kruger hinted that the target could be achieved by year-end. This was yet another positive surprise on the call that caused Suncor's shares to trade higher.

Select asset divestitures could help management reach its net debt target by year-end, even at low oil prices. For example, the company could sell underperforming retail fuel stations or its Commerce City Refinery.

Meanwhile, Suncor’s balance sheet is in good shape. Net debt to adjusted funds from operations is below 1-time. The company’s strong cash flow generation and C$7.5 billion of available liquidity will allow it to easily manage the C$2.6 billion of long-term debt scheduled to mature through 2030.

The Share Price Outlook Improves

These top and bottom-line improvements bode well for Suncor’s free cash flow per share. Based on management's guidance that called for an improved upstream netback, higher downstream margins, additional corporate costs cuts, and a lower share count, we see significant upside in the shares by 2026.

The following table shows our free cash flow per share estimates at different oil prices. It showcases Suncor’s significant torque to oil prices, which drives free cash flow per share higher as oil prices increase.

We believe oil prices will be sustained at higher levels in 2026 and beyond as U.S. shale production matures and OPEC+ remains in control of the market. If WTI averages $85 per barrel in 2026, we estimate Suncor will generate C$8.74 per share of free cash flow, implying a C$72.85 share price and 31.8% upside if the shares trade at a 12% free cash flow yield. At $90 per barrel WTI, the upside increases to 51.2%.

At our current WTI estimate of $87.50 per barrel, we estimate Suncor will generate approximately C$10.8 billion of free cash flow. Our discounted cash flow valuation implies 32% upside from the current share price of C$55.28.

Conclusion

Management’s new guidance shows that the value proposition for Suncor shares is improving. Large share repurchases at discounted share prices will turbocharge per-share metrics. Repurchases could grow larger at year-end if management’s net debt target is hit.

Alternatively, Suncor can increase its dividend to generate a 14.1% dividend yield on the current share price at $80 per barrel WTI. Dividend potential grows significantly at higher oil prices.

Given the upside potential for Suncor’s share price and dividend, we remain committed long-term shareholders of the company. We’ll consider adding to our position as long as the shares trade below C$60 per share for the Canadian listing. We look forward to the higher stock prices and growing dividends that lie in store from management’s continued execution.

Analyst's Disclosure: I/we have a beneficial long position in the shares of SU either through stock ownership, options, or other derivatives.