Suncor Energy (SU) - Q3 2025 Conference Call

Highlights from Suncor's Q3 2025 conference call:

• Upstream production, 870,000 bbl a day in the third quarter, far and away our best third quarter ever. In fact, 41,000 bbl a day higher than our previous best, which was achieved last year.
• Refining throughput, 492,000 bbl a day in the third quarter, our best quarter of any quarter ever, exceeded our previous best, the third quarter of last year. The third quarter is typically the highest throughput quarter each year.
• Recognizing all sales are not created equal, our highest margin retail sales are up 8% year-on-year, while lower margin export sales are down 11% year-on-year. 
• Operating costs, year-to-date OS&G, CAD 9.7 billion, essentially flat with year-to-date 2024. Despite 32,000 bbl a day higher upstream production, 14,000 bbl a day higher refining throughput, and 21,000 bbl a day higher product sales, higher volumes, lower unit costs. 
• Turnarounds, on our second quarter call, we shared second quarter turnarounds were completed at historically low cost and best-ever durations. Our third quarter turnarounds were completed equally well. A couple of examples: Montreal Refinery, our hydrocracker and hydrogen plants. Previously, 55 days to complete the work. We budgeted it at 50. We completed it in 40, going from industry fourth quartile to second quartile. Previously, it cost us CAD 80 million. We budgeted it at 71. We completed it for 62, again going from industry fourth to second quartile. I am really pleased to say it was completed without so much as a cut finger or a spilt barrel.
• We've dramatically reduced our WTI breakeven and at the same time reduced our net debt. We've materially grown free funds flow, fueling higher return of capital to shareholders.
• A few illustrations: third quarter 2025 AFFO, CAD 3.8 billion with WTI at CAD 65 a barrel. Last time we had CAD 3.8 billion AFFO was the third quarter of 2024, with WTI at CAD 75 a barrel.
• Third quarter free funds flow, CAD 2.3 billion, the highest operationally since fourth quarter of 2022 when WTI averaged CAD 83 a barrel, CAD 18 higher. Year-to-date free funds, CAD 5.2 billion, within CAD 200 million of 2024, despite oil prices being CAD 11 a barrel lower. Buybacks, CAD 250 million a month in 2025, every month. Independent of oil price, CAD 250 million when WTI was CAD 75 in January, CAD 250 million when WTI was CAD 61 in May. Year to date, we bought back more than 42 million shares, 3.4% of our float, at an average cost of CAD 53. Year-on-year, CAD 340 million more in buybacks, despite oil prices being down CAD 9 a barrel. At today's oil price, I strongly believe buying our stock is our best investment, and we intend to keep buying it month after month after month.
• Rich has previously described this as our ability to make craft cocktails for our customers. It is this competitive advantage, coupled with our strong logistics and trading capabilities, that enabled us to sell our oil sands barrels at 96% of average WTI over the quarter. Our downstream margin capture is consistently above industry benchmarks. This quarter was no exception, with margin capture at 92% of our custom 5221 index, an index which represents the margin power of our downstream business. LIFO gross margin was CAD 28.87 versus an average New York Harbor and Chicago 321 crack of CAD 26.39. Suncor is quite simply a margin machine, and this should be recognized as a core driver of this company's value proposition.

It would be hard to understand this quarter's oil results without the framework of cornucopianism. Producers are getting more efficient, increasing the supply and driving the price of oil down. ("Higher volumes, lower unit costs.") 

The most efficient, lowest cost producers' profit holds up reasonably well and so do the owners of low cost minerals. It is not great for owners of higher cost minerals! This may be why we are seeing a pronounced divergence between the share prices of Suncor and Dorchester, for example.

The current market capitalization of SU (at a $44.23 share price) is $53 billion and its enterprise value is $61 billion. (Net debt of $5.1 billion plus other liabilities.) Suncor returned $1.02 billion of value to shareholders in the third quarter with $490 million in share repurchases and $530 million in dividends, for an annualized shareholder yield of 7.7% on the current market capitalization. As of October 31 (not September 30) the number of shares outstanding is down 3.8% year-over-year. 

Suncor's adjusted funds from operations was $2.7 billion which was about the same as a year earlier. Capital expenditure was $1 billion which was also the same as the year earlier. The resulting free cash flow for the quarter was $1.7 billion (again, same as in 2024), which is an 11% yield (annualized) on the enterprise value. Capital expenditures were roughly flat while upstream production was up 6%, year-over-year. This was in an environment of $65/bbl WTI compared with $75 a year earlier. As mentioned in the conference call notes above, Suncor kept profits flat despite a $10/bbl oil price decline! (The WCS spread was $10.40/bbl vs $13.50 a year earlier.)

Suncor generated $2.1 billion of funds from operations from oil sands, $200 million from other upstream (e.g. offshore production) and $863 million from downstream (refining and marketing). The refining and marketing helped keep profits flat despite the oil price decline because they generated $366 million more funds from operations than the prior year. 

Suncor's proprietary 5-2-2-1 crack spread was $31.20 versus $26.05 the prior year and the company had higher refinery utilization/throughput, as was mentioned in the call note above. Suncor gets more diesel out of a barrel than a generic refinery refining lighter crude. Also, Suncor captures some of the retail margin via its fuel stations in Canada.

Suncor Energy Inc. (SU) - Q1 2025

The recent Suncor earnings calls have been a delight to read. (Lesson: always invest in companies with CEOs named Rich?) Here are some highlights from the latest quarter (Q1 2025) earnings call:

• In 1954, a gentleman named Roger Bannister, the world’s first four-minute milers and records are meant to be broken, and that is exactly what Suncor teams continue to do break records. Total cost, OS&G $3.3 billion, down $143 million or 4.2% in absolute dollars versus the first quarter of last year despite higher production and throughput across the board. 3% to 4% higher absolute volumes, 4% lower absolute costs operating leverage achieved with a culture and a mindset that every barrel and every dollar matter.
• The mine is supported by a fleet of 70 to 75 Caterpillar 797 400-ton haul trucks. Historically, we’ve loaded each truck to 93% of capacity or 370 tons per truck. Alex’s team has increased its load factor to over 100% now, a full 10% increase, 30 to 40 more tons of productive ore on each and every truck, achieved through shovel operator best practices and load sensing technology, the impact, lower unit costs, higher productivity equal to 73 400-ton trucks.
• I personally pulled out my stop watch on my phone and time loading operations, four scoops, 404 tons in one and a half minutes, folks, that’s fast
• I think it’s worth noting that when comparing quarter-over-quarter Q1 2025 to Q1 24 despite a 7% decline in WTI an average 24% decline in New York Harbor and Chicago 211 cracks, you see that our AFFO per share is the same and our free fund flow per share is actually 6% higher.
• Winners always want the ball when the game is on the line.
• The only thing I unconditionally love are my kids and my grandkids. Everybody else has to earn their seat at the table.

The current market capitalization of SU (at a $34.31 share price) is $42 billion and its enterprise value is $50 billion. (Net debt of $5.4 billion plus other liabilities.) Suncor returned approximately $1.08 billion of value to shareholders in the quarter with $540 million in share repurchases and $508 million in dividends, for a shareholder yield of 10.3% on the current market capitalization. 

The number of shares outstanding is down 4.2% year-over-year. They bought back 5 million shares in April. They were doing 4.5 million/mo in Q1.

Suncor's adjusted cash from operations, excluding change in non-cash working capital, was $2.19 billion, compared with $2.28 billion a year earlier. Capital expenditure was $824 million compared with $944 million. The resulting free cash flow for the quarter was $1.37 billion (compared with $1.34 billion), which is an 11% yield (annualized) on the enterprise value.

Capital expenditure was down 13% while upstream production was up 2%, year-over-year. 

This was in an environment of $71.40/bbl WTI vs $76.95 a year earlier. Luckily, the differential between WCS and WTI fell from $19.35/bbl a year ago to $12.65 in the first quarter. 

It is obviously not good that WTI has dropped to $60/bbl. Suncor produces about ~310 million barrels of oil a year so a ~$10/bbl hit to crude costs us $3 billion annually assuming that differentials and refining margins remain the same. (Crack spreads are currently higher than last quarter.) That's a huge chunk of our cash flow. It amounts to $2.44 per Suncor share. Trump's trade war is costing us real money!

Earnings Notes I (Q4 2024)

Exxon Mobil Corporation (XOM)
Exxon's free cash flow for the fourth quarter of 2024 was $8 billion, which was the same as a year earlier. For the full year, Exxon generated $34 billion of free cash flow versus $36 billion in 2023. (Note that Exxon acquired Pioneer Natural Resources in May 2024 for $60 billion, which added a large amount of production in the Permian.) The market capitalization of Exxon (at $108 per share) is $478 billion and the enterprise value is $500 billion, which puts the annualized FCF/EV yield at 6.4%.

Exxon's upstream earnings were $6.5 billion for the quarter (up 5.5% y/y), downstream earnings were $0.4 billion (down 70% y/y), chemical earnings were $120 million (down 87% y/y), and specialty products earnings were $746 million (down 6% y/y).

Imperial Oil Limited (IMO)
Imperial's free cash flow for the fourth quarter of 2024 was $3.5 million (USD), which was up 54% from a year earlier. For the full year, Imperial generated $2.9 billion of free cash flow versus $1.4 billion in 2023. The market capitalization of Imperial (at $66 per share) is $34 billion and the enterprise value is $36 billion, which puts the annualized FCF/EV yield at 10.8%.

The share count was down 5% year-over-year. They returned a total of $2.7 billion to shareholders in 2024, which is a shareholder yield of 8%. On the operations side, Imperial's cash cost per barrel in 2024 was $3 (USD) lower than in 2023. (Cornucopian.)

Suncor Energy Inc. (SU)
Suncor's free cash flow for the fourth quarter of 2024 was $2.5 billion (USD), which was up 27% from a year earlier. The market capitalization of Suncor (at $38.41 per share) is $49 billion and the enterprise value is $57 billion, which puts the annualized FCF/EV yield at 17.5%. They returned a total of $2.1 billion by way of share repurchases, dividends, and debt repayment in the fourth quarter, which is a yield on the market capitalization of 17%. Suncor has hit its net debt target and is now focused on buybacks and dividends. The oil sands segment produced 539k bbl/d in the fourth quarter with a cash operating cost of $18.59, which was down 14% ($3 per barrel) from the year earlier. 

Intercontinental Exchange Inc. (ICE)
For the full year 2024, ICE earned $3.9 billion of free cash flow on $9.3 billion of total revenue (less transaction-based expenses) for a royalty-like 42% free cash flow margin. Free cash flow for 2024 was up 26% from the prior year. The current market capitalization is $92 billion and the enterprise value is $113 billion, which makes the FCF/EV yield 3.5%.

Enterprise Products Partners L.P. (EPD)
The $0.74 earnings for the fourth quarter are a 9% annualized yield on the current unit price of $32.78. The quarterly distribution is only $0.535 because they are retaining earnings, so the current dividend yield is ~6.5%. The big question with Enterprise is whether all of the "growth" investments pay off by resulting in higher free cash flow generation? If so, cash from operations would increase and capital expenditures would (hopefully) decrease, resulting in a lot more cash available for distributions to unitholders.

General Motors Company (GM)
Was surprised to see that General Motors shares outstanding ended the year 17.53% lower. The market capitalization is $48 billion and in 2024 GM generated $20 billion of cash from operations, spent $11 billion on capital expenditures, and did $7 billion of share repurchases.

Oil and Gas Earnings Notes (Q1 2024)

We wrote about Exxon, Chevron, and Imperial Oil earnings in a post last month. Now, let's look at our big Canadian producers (CNQ, SU, CVE), our royalty owners (DMLP and TPL; we already looked at PREKF results), and our two big refiners (MPC and VLO).

Canadian Natural Resources Limited
The current market capitalization of CNQ (at a $76 share price) is $81 billion, and the enterprise value is $88 billion. Cash from operations for the first quarter (results) was $2.12 billion and the company spent $773 million on capital expenditures. The remaining free cash flow for the quarter was $1.35 billion, which is a 6% yield on the enterprise value.

Capital expenditures were down 11.5% from the first quarter of 2023, while production of liquids was up 1.3% and total production (including natural gas) was up 1.1%. They averaged 976k bbl/d of liquids during the quarter. The realized price of oil per barrel was $52 for crude and $66 for synthetic crude, compared with $44 and $71 the prior year.

The company spent $796 million on dividends and $448 million on share repurchases for a shareholder yield of 6%. The diluted share count is down 2.9% year-over-year. Regarding capital allocation, management said on the conference call: "2024 marks an important milestone as we are delivering 100% of free cash flow to shareholders this year. And with strong crude oil strip pricing for the remainder of the year, we are targeting to generate significant free cash flow."

Suncor Energy Inc.
The current market capitalization of SU (at a $39.50 share price) is $51 billion, and with $10 billion of net debt, the enterprise value is $61 billion. Cash from operations for the first quarter (results) was $2.06 billion and the company spent $915 million on capital expenditures. The resulting free cash flow for the quarter was $1.15 billion, which is a 7.5% yield (annualized) on the enterprise value. During the quarter, Suncor returned $736 million via repurchases and dividends, for an annualized shareholder yield of 5.8%.

Capital expenditures were up 20% from the first quarter of 2023, while production was up 12.5%. They averaged 835k bbl/d of production during the quarter, which was a record, including all-time high oil sands production of 785k bbl/d from oil sands. Refining throughput of 455k bbl/d was also the highest in company history. The upstream segment earned $1.2 billion pretax and the refining and marketing segment earned $824 million, for a total of $1.2 billion of net after-tax earnings.

Cenovus Energy Inc.
The market capitalization of CVE is $37.5 billion (at a $20 share price) and their enterprise value is $43.4 billion. The upstream segment earned $1.2 billion of operating margin during the first quarter (results) (compared with $613 million the prior year) and the downstream (refining) segment earned $294 million (compared with $186 million earned the prior year).

Upstream capital expenditures were up 6.4% year-over-year, to $690 million for the first quarter. Upstream production volumes were 801k boe/d, up 2.8% year-over-year. Cash from operations for the quarter was $1.42 billion which puts free cash flow at $745 million, for an annualized yield of 6.8% on the enterprise value.

During the first quarter, the company spent $194 million on common share dividends and $122 million on share repurchases. The $316 million returned to shareholders is a shareholder yield of 3.4% on the current market capitalization. Net debt at the end of the quarter was $3.6 billion. Management has said that they will increase shareholder returns (from 50% of "excess free funds flow" to 100%) once net debt drops below $3 billion.

Dorchester Minerals, L.P.
The market capitalization of DMLP is now $1.3 billion (at $32 per unit). For the first quarter of 2024 (10-Q), the partnership earned $18 million of net income (compared with $28 million the prior year), generated $28 million of cash from operations (compared with $39 million the prior year), and distributed $40 million to unitholders. The CFO yield on the market capitalization is 8.6% (annualized). The annual shareholder meeting was on May 15 and the company has released the investor presentation. The most recent (second quarter) distribution was $0.782 cents, paid on May 9. Over the trailing four quarters, the partnership has distributed $3.31, which is a 10% yield on the current unit price.

Texas Pacific Land Corporation
The market capitalization of TPL (at $600 per share) is now $13.9 billion. (The company had a 3-for-1 share split during the first quarter.) The company has built up quite a cash pile during the shareholder activism dispute, so the current assets net of liabilities are $900 million and the enterprise value is $13 billion. The company owns 868,000 surface acres, which is an enterprise value of $15,000 per acre just for the surface.

In the first quarter of 2024 (10-Q), production volumes for TPL were 24,800 BOE per day, which was up 19% from the prior year. Their oil volumes at 0.99 million total barrels for the quarter were up 25% year-over-year. Oil and gas royalty revenue was up only 3.4% year-over-year because natural gas prices were down. Water sales, water royalties, and easement income were all up year-over-year, although the water service business has operating expenses, which were also up. (TPL's "land and resource management" segment had an adjusted EBITDA margin of 94% and its "water service and operations" segment had a 75% margin.)

Total expenses were $34.3 million (excluding depreciation) versus $38 million the prior year. Thankfully legal fees were only $4 million this quarter and not the $16.6 million spent in the year ago quarter. Expenses (again excluding depreciation) were 20% of total revenue, partly because TPL has established a "water services" business which is lower margin than collecting royalty revenue.

Operating income was $136 million for the quarter, and if you add back $3.8 million of depreciation, depletion, and amortization, you get a "cash flow-like number" of $140 million, which would be an annualized yield of 4.3% on the current enterprise value.  

The company published a May 2024 investor presentation as well as a presentation on produced water desalination and beneficial reuse.

Marathon Petroleum Corporation
This Marathon is the refiner, not the E&P company (MRO). They refine almost 3 million barrels per day, which is the most in the U.S., followed by Valero (VLO) and ExxonMobil (XOM), each with about 2 million barrels per day. 

At the current share price of $172, the market capitalization of MPC is $60.6 billion and the enterprise value is $82 billion. During the first quarter (release), Marathon's refining and marketing segment earned adjusted EBITDA of $1.9 billion and its midstream segment earned $1.6 billion, for total adjusted EBITDA of $3.3 billion. The refining capacity utilization was only 82% during the quarter, compared with 89% the prior year (when refining EBITDA was a much higher $3.9 billion).

Cash from operations was $1.5 billion and the company had $585 million of capex during the quarter. The company repurchased $2.2 billion of stock and paid $300 million of dividends, for total shareholder returns of $3 billion, a 20% annnualized shareholder yield. (The company's cash balance drew down by $2.3 billion as they outspent cash flow.)

Valero Energy Corporation
At the current share price of $157, the market capitalization of VLO is $51 billion and the enterprise value is $57 billion. During the first quarter (release), Valero's refining segment earned operating income of $3.5 billion and its renewable diesel and ethanols segments earned a combined$200 million.

Cash from operations was $1.85 billion and the company had $660 million of capex during the quarter. The company repurchased $1 billion of stock and paid $356 million of dividends, for total shareholder returns of $1.38 billion, an 11% annualized shareholder yield.

Earnings Notes III (Q4 2023)

Chesapeake Energy Corporation (CHK)
Investors liked Chesapeake's earnings announcement this week, sending shares up about 10%. The key was that the company promised to cut capital expenditures and let production fall! They said that they will cut capex by 20% and expect production to be 22% lower in 2024 than 2023. That's a difference of 770 million cubic feet which is about 0.65% of U.S. production; not insubstantial. Chesapeake's announcement was also enough to lift the futures curve for natural gas.

The market capitalization (after the release) is now $11 billion. The company has $1 billion of net debt so the enterprise value is $12 billion. During the fourth quarter of 2023, cash from operations was $470 million and capital expenditures were $379 million for free cash flow of only $91 million, a FCF yield on the enterprise value (annualized) of a mere 3.3%.

Chesapeake is not earning its cost of capital at these natural gas prices, but with so little debt, you have a call option on natural gas that is not in immediate danger of expiring. Management points out in the investor presentation that there is going to be 12 bcf/d of LNG export capacity coming online by 2028. They think that the realized netback per MCF will be $4-6, far above the current $2.87 average realized price in the third quarter. With a cash production cost of over $1/mcf, there is subsantial leverage to higher natural gas price if LNG export drives a higher commodity price. (At $5/mcf, earnings more than double.)

Still, there are other ways to get exposure to natural gas that do not require so much capital and operating expenditure. Dorchester Minerals (DMLP) is getting about one-third of production (in BOE terms) from natural gas, which is being practically given away for $2/mcf. And we will look at Blackstone Minerals and Kimball Royalty Partners below.

Marathon Petroleum Corporation (MRO)
This Marathon is the E&P company, not the refiner (MPC). Another capex cut! Management said in the earnings release that investors should "expect 5% to 10% fewer net wells to sales in 2024 to deliver flat year-on-year total oil production as the Company optimizes well mix to maximize corporate returns and FCF generation." Very nice.

Also up about 8% after earnings, so the current market capitalization is $14 billion. They didn't publish a balance sheet with the Q4 release, but the enterprise value should be about $20 billion. During the fourth quarter of 2023, cash from operations was $1.1 billion and capital expenditures were $360 million for free cash flow of $681 million, a FCF yield on the enterprise value (annualized) of 13.6%. Shareholder returns during the fourth quarter (mostly repurchases) were $417 million, which is a shareholder yield of 12% (annualized). Their guidance for 2024 is $1.9 billion of free cash flow, assuming $75/bbl WTI and $2.50/MMBtu Henry Hub natural gas. That would be a 9.5% yield on the enterprise value.

Suncor Energy Inc. (SU)
The current market capitalization of SU (at a $33.50 share price) is $43.5 billion, and with $10 billion of net debt, the enterprise value is $54.5 billion. Cash from operations for the fourth quarter was $3.2 billion and the company spent $1.1 billion on capital expenditures. The resulting free cash flow for the quarter was $2.1 billion, which is a 15% yield (annualized) on the enterprise value. In the fourth quarter, Suncor returned $1.15 billion via repurchases, dividends, and debt repayment for an annualized shareholder yield of 10%. The fully diluted share count was down 3.5% y/y at the end of the year.

Upstream production was up 6% year over year to 808,100 barrels per day in the fourth quarter. Refinery utilization was 98% versus 94% the prior year quarter. Upstream capital expenditures were up 17% year-over-year, for a "production shortfall" of 11%. Oil sands "base" capex was up only 5% and production was up 10%, for a negative production shortfall. This is what we want to see from our slow decline oil sands with front loaded cost!

The oil sands segment generated funds from operations for the fourth quarter of $1.9 billion, with a production volume of 757 thousand barrels per day and an average crude price realization of $61/bbl. The refining and marketing segment generated funds from operations of $592 million, processing 456 thousand barrels per day and making a gross margin (LIFO) of $34.35 per barrel.

Texas Pacific Land Corporation (TPL)
The market capitalization of TPL (at $1,563 per share) is now $12 billion. The company has built up quite a cash pile during the shareholder activism dispute, so the current assets net of liabilities are $749 million and the enterprise value is $11.25 billion.

In the fourth quarter of 2023 (8-K), production volumes for TPL were 26,300 BOE per day, which was up 23% from the prior year. Oil volumes were up the same amount. This was the highest quarterly royalty production level in TPL history. Royalty revenue was up 2% thanks to the higher volumes, even though the price of oil was $78.46 versus $83.16 the prior year. Water sales, water royalties, and easement income were up 37% year-over-year, although the water service business has operating expenses, which were up.

Total expenses were $29 million (excluding depreciation) versus $25 million the prior year. Thankfully legal fees were only $3 million this quarter and not the gigantic $17 million we saw one quarter earlier this year during the heat of the shareholder activist battle.

Interesting to note that the expenses (again excluding depreciation) are a hefty 17% of total revenue. That's partly because TPL has established a "water services" business which is lower margin than collecting royalty revenue.

Operating income was $134 million for the quarter, and if you add back $3.9 million of depreciation, depletion, and amortization, you get a "cash flow-like number" of $138 million, which would be an annualized yield of 4.9% on the current enterprise value. (It was up 8.9% year-over-year.) For the full year, the company spent $100 million on dividends and $43 million on share repurchases. 

The share count shrank by only 0.33%; management let net current assets grow by $225 million during the year, to $818 million. That cash could have been used to shrink the share count an additional ~2% if it had been deployed at times when the share price was weak.

Black Stone Minerals LP (BSM)
Black Stone Minerals is another publicly traded minerals partnership. They had an IPO in 2015 although predecessor entities have been around much longer. They are bigger than Dorchester, with a market capitalization of $3.2 billion. Current assets net of all liabilities are $144 million and there is also $300 million of convertible preferred, making the enterprise value $3.4 billion. (The convertible preferred gets a quite expensive ten year yield plus 5.5% distribution rate, which is currently 9.8%.)

For the fourth quarter, BSM reported distributable cash flow of $119 million on total revenue of $191 million, which represents a yield of 15% on the market capitalization. Oil production was 1 million barrels and natural gas production was 16.5 bcf; production was therefore almost three quarters in terms of energetic equivalent BOEs. (But oil was a much greater percentage in terms of revenue.)

Something different about Black Stone compared with Dorchester is that they hedge their production. They have 570,000 barrels swapped for each quarter of 2024 at $71.45/bbl and 210,000 barrels swapped for each quarter of 2025 at $70.50 per barrel. That's about half of 2024 and a quarter of 2025 production hedged. For natural gas they have around 10 billion bcf swapped for each quarter of 2024 at $3.56 per bcf and 1 billion bcf for each quarter of 2025 at $3.65 per bcf. That's 60% of this year and a small proportion of next year.

Heading into 2023, they had swapped natural gas at $5/mcf, which obviously has supported the trailing distributions. Also noteworthy is that one of the big drillers on their Haynesville acreage (Aethon) is taking a "time out" on its drilling commitments due to low gas prices. So both volumes and prices will be lower in 2024, plus the preferred stock yield reset from 7% to 9.8% in November 2023, which will reduce income to common by a further $8.4 million per year.

Why hedge? Unlike Sitio, Black Stone does not have significant leverage. It sounds like they are bullish on natural gas over the longer term, once more LNG export capacity opens. Anyway, this is one to keep in mind if we were to get bullish on natural gas. A $5 natural gas price might give them an extra $125-150 million of earnings every year, which would be a decent boost to the current cash flow yield. (Of course, that would be assuming that management didn't bungle it with a hedging trade.)

Kimbell Royalty Partners LP (KRP)
One last publicly traded mineral partnership. Something interesting is that KRP is a limited partnership that has elected to be taxed as a corporation, so there is no K-1. There is a good bit of nepotism in the C suite to be aware of. Robert Ravnaas is the Chairman and CEO; David Ravnaas is the President and CFO, and there is also a Rand Ravnaas as VP of Business Development. KRP had its IPO in 2017 and has grown from acquisitions in 2018, 2019, 2022, and 2023.

Kimbell has a market capitalization of $1.5 billion. They have $269 million of net debt and $325 million of convertible preferred stock outstanding, for an enterprise value of $2.06 billion. Production in Q4 was 24k boe/d, coming mostly (55%) from the Permian and the Haynesville. Their recent investor presentation gives more guidance than other partnerships. They estimate that at $2 natural gas and $80 oil, their distribution (at a 75% payout ratio) would be $1.61, which would be a 10.4% yield on the current price.

Kimbell also hedges - they swapped about 140k bbl of oil and 1.3 bcf of natural gas for each quarter for the next two years (2024-2025) at prices ranging from $82-67/bbl for the oil and $3.52-$4.32/mcf for the natural gas. That is about a quarter of their oil and gas production levels.

As we mentioned in the past about Sitio, we are not big fans of borrowing (expensive capital) to buy mineral properties and then hedging the commodity price. It seems like the outcome that mainly delivers is scale. We can see how that would be important to insiders, though, since they get paid as a function of scale. The CEO of KRP was paid $5.2 million in 2023 and his son was paid $4.7 million. The CEO owns $17 million of common units and his son owns $11.7 million. 

Our humble opinion is that Dorchester has the simplest, cleanest model with the fewest moving parts, least promotional management, and longest track record.

Sprouts Farmers Market (SFM)
We wrote about Sprouts back in October 2023. At that point, the market capitalization was $4.3 billion and the enterprise value was $5.8 billion. Shares have been on a tear and the market capitalization is now $5.5 billion (+28%).

What we like about Sprouts is two things. First, the Sprouts stores are extremely well run and well merchandised, putting pressure on (and taking customers from) the tired old grocers that are owned by Kroger and Albertsons. Second, the business generates free cash flow even while expanding, which the company has been using to cannibalize its own shares. During 2023, Sprouts grew the share count by 21 net (5%) to 407 stores while shrinking the share count by 5.3%.  

For the full year 2023, Sprouts did $6.8 billion of sales (up 6.8% versus 2022) and generated $465 million of cash from operations (7% OCF conversion), spending $238 million on capital expenditures and an acquisition (compared with $265 million of depreciation and amortization), while paying off $125 million of debt, and repurchasing $203 million of stock.

As we said, the market capitalization is $5.5 billion and the enterprise value is $7 billion. That gives a FCF/EV yield of 3.2%. Reported net income per share (diluted) is $2.50 for the year, which gives a P/E ratio of 21.5x, and which was up 4.6% y/y. Management guidance is to open 35 new stores in 2024, with total revenue growth in the mid single digits.

Canadian Oil Producer Earnings ($SU $CVE $CNQ)

[Previously regarding Suncor Energy, Cenovus Energy, and Canadian Natural Resources Limited.]

Canadian Natural Resources Limited
Once again, an outstanding result from the titan of the Canadian energy industry. Third quarter capital expenditures were up only 2.3% with liquids production up 5.2% year-over-year. Their production volume of 1.4 million BOE/d was the highest quarterly volume in the history of the Company.

Management said that "with current strong production volumes and expected free cash flow in Q4/23 and beyond, based on current strip pricing, we are quickly approaching a net debt level of $10 billion, which we forecast to achieve in Q1/24, at which time we target to increase returns to shareholders to 100% of free cash flow." The share count was down 2.4% year-over-year at the end of the third quarter - it would be nice to see the repurchases accelerate.

The current market capitalization of CNQ (at a $67 share price) is $73 billion, and the enterprise value is $82 billion. Cash from operations for the third quarter was $2.6 billion and the company spent $875 million on capital expenditures. The remaining free cash flow for the quarter was $1.7 billion, of which $534 million was used for debt repayment, $718 million was used for dividends, and $434 million was used for share repurchases. The free cash flow yield on the enterprise value was 8.3% based on the quarter's results. 

This was during a quarter with an average WTI price of $82 and an averaged realized price for liquids by CNQ of $64. In its latest investor presentation, CNQ says that free cash flow per share would be 30% higher at $100 WTI than at $85 WTI. (Notice also on slide 8 of the presentation, CNQ management points out that oil sands mining and upgrading requires much less capital expenditure to maintain production than shale.)

On the CNQ conference call, management was asked (by the Goldman Sachs analyst Neil Mehta) whether they were interested in M&A in Canada. The CEO said that "we have a huge reserve base... we don’t have to do any acquisitions to create or find more reserves, so we have that part in the bag."

Suncor Energy Inc.
The current market capitalization of SU (at a $32.50 share price) is $42 billion, and the enterprise value is $51 billion. Cash from operations for the third quarter was $3 billion and the company spent $1.1 billion on capital expenditures. The remaining free cash flow for the quarter was $1.9 billion, of which $1.3 billion was used for debt repayment, $489 million was used for dividends, and $217 million was used for share repurchases. The free cash flow yield on the enterprise value was 14.9% based on the third quarter's (annualized) results. The shareholder returns (repurchases and dividends) for the quarter are a 6.7% shareholder yield. The company has bought back 3.5% of shares outstanding YTD. Suncor's earnings per share were 86 cents, so a P/E of 9x. 

Funds from operations were down versus the third quarter of last year, but up significantly from the second quarter of this year. One key performance metric was that refinery utilization was 99% for the quarter instead of 85% the prior quarter.

Some highlights from the conference call:

*On October 3, we announced a revised deal to acquire Total Canada for $1.468 billion. This is an improved deal versus the original deal. Specifically, we no longer have a contingent payment provision in the acquisition. Similar headline valuation to the earlier Teck deal, but we’ve got additional benefits. Commercial patience and persistence were key here, and we’re pleased with the deal. We’re on track to close the transaction later this month. It addresses long-term bitumen supply uncertainty associated with our upgraders, fills our upgraders for the long-term, but also enables additional value creation, value creation through regional synergies, with mobile equipment deployment, value creation through directing higher yield PFT from Fort Hills to our upgraders, a number of incentives and, as I said, we’re quite pleased with the deal.

*Let me move on to mining fleet performance for context. The cost of physically moving ore from the face of a mine to a crusher for the start of extraction, that’s our single highest cost component in the production of bitumen. Today, we move about 1.3 billion tons of earth per year to support production, and we’ve got a competitive cost gap versus best-in-class, comprehensive efforts to lower our cost per ton. The winning formula, fewer trucks, bigger trucks, more efficient trucks, and, of course, companion or compatible shovels, that’s our mining improvement strategy in a nutshell. So, this year and throughout 2024, we will add via a combination of purchase and lease 55 ultra-class 400-ton trucks to our total fleet, displacing nearly twice as many smaller third-party, less efficient, higher cost vehicles. Each truck will be pre-equipped for ultimate driverless or autonomous operation. The cost for these acquisitions and leases are in our guidance for this year, as well as our guidance that we’ll issue shortly for 2024. Once in place, this action alone is expected to lower our overall corporate breakeven by $1 a barrel.

*I suspect you’ve noticed a few references today in terms of per barrel. This reflects a new and evolving vocabulary within the company, thinking about and communicating the impact of our actions, plans, and improvements in unit per barrel terms. In addition, a subset of us similarly talk about the impact in per share terms. Our vocabulary is part of creating clarity and focus, developing a results-oriented, high-performance culture.

The oil sands segment generated funds from operations for the third quarter of $1.27 billion, with a sales volume of 656 thousand barrels per day and an average crude price realization of $74/bbl.

The refining and marketing segment generated funds from operations of $1.1 billion, processing 463 thousand barrels per day and making a gross margin (LIFO) of $31 per barrel.

Cenovus Energy Inc.
The market capitalization of Cenovus (CVE) is now $33 billion (at a $17.5 share price) and the enterprise value is $40 billion. The upstream segment earned $2.5 billion of operating margin during the third quarter (compared with $2.1 billion the prior year quarter) and the downstream (refining) segment earned $673 million (compared with $358 million).

Their free cash flow (as we define it, CFO less capex) was $1.24 billion for the quarter, which gives a free cash flow yield on the enterprise value of 12.4%.

In the third quarter, the company returned $876 million to shareholders by way of $438 million for the partial payment of the common share warrants obligation, the repurchase of 13.8 million shares for $264 million, and $193 million of common dividends. The shareholder yield on the market cap was 10.6% (annualized).

The company also repaid $973 million of debt. Cenovus’s shareholder returns framework has a target of returning 50% of excess free funds flow to shareholders for quarters where the ending net debt is between $6.5 billion and $2.9 billion. (Net debt is down to $4.3 billion as of the end of the third quarter.)

Capital expenditures for the third quarter in their upstream segment were up 74% year-over-year while production of crude oil was up only 3%. For the current year-to-date, the upstream capital expenditures are up 68% while crude oil production is up only 1% compared to the first nine months of last year.

Canadian Oil Earnings ($CVE $SU $CNQ $PREKF)

[Previously regarding Suncor Energy, Cenovus Energy, Canadian Natural Resources Limited, and PrairieSky.]

Suncor Energy: the market capitalization is now $41 billion (at a $31.5 share price) and the enterprise value is $53 billion. They reported earnings for the second quarter of 2023 of $1.4 billion (figures in USD), which means that shares are trading for seven times net (annualized) earnings. This was with an average WTI crude oil price of $73.75/bbl for the quarter, a $15/bbl discount for WCS, and a $2.90/bbl premium for Syncrude.

Upstream production was up 3% year-over-year, from 720k bbls/d in Q2 2022 to 742k bbls/d this quarter. Upstream capital expenditures were up 20% year-over-year, for a "production shortfall" of 17%. (Compare with shale players like OXY, where the production shortfall in the Permian this quarter was 51% or Devon, which had a production shortfall of 80%.)

Suncor's free cash flow for the quarter was $782 million, which is a 6% yield on the current enterprise value. They returned $1.04 billion to shareholders during the quarter, equally split between share repurchases and dividends, for a shareholder yield of 10% (annualized). The refining operating income was down 75% y/y even though their proprietary Suncor 5-2-2-1 index (crack spread) was only down 33%.

Cenovus Energy: the market capitalization is now $37 billion (at a $19.70 share price) and the enterprise value is $45 billion. They reported earnings for the second quarter of 2023 of $643 million (figures in USD), which means that shares are trading for 14 times net (annualized) earnings.

Upstream production was down 4% year-over-year, from 762k bbls/d in Q2 2022 to 730k bbls/d this quarter. Upstream capital expenditures were up 61% year-over-year, for a "production shortfall" of 57%. (Note that the production levels were reduced by wildfires in Alberta this year, which explains part of the shortfall.)

Cenovus's free cash flow for the quarter was $741 million, which is a 7% yield on the current enterprise value. They delivered $427 million to shareholders in the second quarter through buybacks and common share dividends; plus they repurchased 45.5 million of their outstanding warrants for $528 million.

Canadian Natural Resources: the current market capitalization (at a $61.76 share price) is $67 billion, and the enterprise value is $76 billion. They reported earnings for the second quarter of 2023 of $1.1 billion, which means that shares are trading for 15 times annualized earnings. 

Upstream production was down 1.6% year-over-year, from 1.21 million BOE/d a year ago to 1.19 million this quarter. Capital expenditures (CNQ has no downstream) were up 15% year-over-year, for a "production shortfall" of 17%.

CNQ's free cash flow for the quarter was $807 million, which is a 4% yield on the current enterprise value. They delivered $1.1 billion of shareholder returns, comprised of approximately $742 million of dividends and approximately $370 million of share repurchases, for a shareholder yield of 6.6%.

PrairieSky: the market capitalization of Prairie Sky (at $19.50 per share for the U.S. ADR) is $4.7 billion and the enterprise value with $216 million of net debt is $4.9 billion. They reported earnings for the second quarter of 2023 of $36 million, which means that shares are trading for 33 times net (annualized) earnings.

Realized pricing was down 37% y/y and production was down 10% y/y (although oil production was actually up 3%) resulting in revenue down 40%.

Cash from operations was $71 million for the quarter, a 6% yield on the current enterprise value.

Canadian Oil Sands Earnings - Suncor and Cenovus ($SU $CVE)

[Previously regarding Suncor Energy and Cenovus Energy.]

Suncor Energy: the market capitalization is now $38 billion (fully diluted, at a $28 share price) and the enterprise value is $48 billion. They reported earnings [pdf] for the first quarter of 2023 of $1.5 billion (figures in USD), which means that shares are trading for just over six times net (annualized) earnings. Their adjusted funds from operations for the quarter were $2.2 billion, which gives an annualized AFFO/EV yield of 18%. This was with an average WTI crude oil price of $76/bbl for the quarter, a $24.75/bbl discount for WCS, and a $2.1 premium for Syncrude.

Suncor's earnings held up much better than the shale companies' earnings. Upstream earnings went from $1.6 billion in Q4 to $1.4 billion in Q1. Downstream (refining and marketing) earnings went from $1.1 billion to $725 million. Having a lower production cost and having downstream businesses reduces the leverage to the oil price. 

During the first quarter, Suncor spent $800 million on capital expenditures compared with $638 million on share repurchases and $500 million on dividends. That gives a shareholder yield (annualized) of 12% on the current market capitalization. From the end of Q1 through May 5th, Suncor repurchased more than 8 million shares which is 0.66% of the outstanding.

As we mentioned in the post about Marathon and Occidental, Suncor's oil sand production in the first quarter was down about 2% and total upstream production was down 3% versus the prior year. That was with total capital expenditures up 6%, oil sands capex up 21%, exploration and production capex up 66%, and total upstream capex up 26%.

In the most recent annual information form (PDF, 2022), Suncor gives the estimated net present value of its proved plus probable reserves, after income taxes and at a 10% discount rate, as $39 billion. This is lower than the estimate of $50 billion at the end of 2021, primarily because the commodity price has fallen. That ignores the value of the refining and market business, which earned an average of $3.1 billion/year over the past two years. Suncor also estimates that they have 5.5 billion barrels of oil equivalent of proved and probable reserves, which is an enterprise value of under $9 per barrel. (Note, that is a 20 year reserve life at the current production level of 270 million barrels per year.)

One last development that came out today is that ConocoPhillips has elected to exercise their right of first refusal with respect to the Surmont asset that Suncor is buying from Total. Suncor said that their agreement to close the transaction was conditional upon ConocoPhillips waiving its right of first refusal, and so they will be "assessing the transaction in light of this change."

Cenovus Energy: the market capitalization is now $32 billion (at a $16.70 share price) and the enterprise value is $37 billion. They reported earnings [pdf] for the first quarter of 2023 of $464 million (figures in USD), which means that shares are trading for just over 17 times net (annualized) earnings.

The company had a disappointingly weak first quarter. The upstream was hurt by the lower oil price and lower production volumes. Downstream margin was 30% lower than in the fourth quarter due to various refining problems. Their adjusted funds from operations for the quarter were $1 billion, which gives an annualized AFFO/EV yield of 11%.

During the first quarter, Cenovus spent $800 million on capital expenditures, $84 million on debt repayment, $29 million on share repurchases, and $146 million on common share dividends - a pitiful shareholder yield.

Capital expenditures in the upstream segment were $639 million for Q1 2023 versus $377 million in Q1 2022, an increase of 70%. (Downstream capex was flat.) The oil sands production was down about 1% y/y, liquids production was down 3%, and total upstream production was down 2.5%. The oil sands capex specifically was up 69% year over year. 

Cenovus did say that "oil sands production expected to be stronger in the second half of the year due to pad timing". However, if you look at slide 11 of the investor presentation [pdf], they give an estimated incremental production of 125k bbl/d from various growth and optimization expenditures in the upstream. That would be 16% growth, but it is expected to happen over a multi-year period.

We are going to be paying close attention in the second quarter to whether the big increases in capex at oil companies are having any effect on production volumes. So far, Suncor seems to be the best of the producers in terms of the capex required to maintain production. Overall, what we saw in results this quarter seems bearish for most producers and bullish for the oil price and for royalty companies.

Suncor Energy to Acquire TotalEnergies' Canadian Operations for $5.5 Billion ($SU)

We wrote in October about Suncor:

They had previously announced that they sold their wind and solar assets to a Canadian utility, and that covers much of the cost of this working interest purchase. The one remaining partner in Fort Hills is a French energy company that thinks oil will be obsolete by 2050. It is a great sign that our management is picking up barrels, and hopefully they will buy out the stupid, politically correct French super-major oil company.

Suncor just announced today that they did it!:

[We have] agreed to purchase TotalEnergies' Canadian operations through the acquisition of TotalEnergies EP Canada Ltd., which holds a 31.23% working interest in the Fort Hills oil sands mining project (Fort Hills) and a 50% working interest in the Surmont in situ asset. This will add 135,000 barrels per day of net bitumen production capacity and 2.1 billion barrels of proved and probable reserves to Suncor's oil sands portfolio. The acquisition is for cash consideration of $5.5 billion, with the potential for additional payments of up to an aggregate maximum of $600 million, conditional upon Western Canadian Select benchmark pricing and certain production targets. [...]

With Suncor's strong balance sheet the acquisition will be funded by debt. As a result, it is expected that net debt levels will temporarily exceed the company's $12-15 billion target range. The company will maintain the current allocation of funds flow after dividends, capital and non-operational benefits of 50% to debt reduction and 50% to share buybacks in line with the capital allocation framework. Suncor expects to return to within its target net debt range in 2024 based on current expected commodity prices. The acquisition is expected to strengthen the underlying business, result in increasing funds flow and be accretive to funds flow per share. Assuming the acquisition closes as contemplated, the Board currently intends to increase the quarterly dividend by approximately 10% following closing.

Excellent! As someone put it on a message board:

To sell 2 billion barrels of fully developed operational oil reserves + the tax pools for 6 billion is wild considering Canada is just aboot (hehe) to finish Transmountain essentially the day this deal closes. 

Less than $3 per barrel of reserves added. (Recall the Canadian producer equities trade at about 2x that.) You can see Suncor's presentation about the deal.

So far it seems as though we have made a good bet about which producers to own: not the woke super-majors, which put money into ESG boondoggles; not the U.S. shale players with short reserve lives; but Canadian oil sands with long reserve lives and heavy crude.

Suncor is due to announce Q1 results on May 8.

Energy - Q4 2022 Earnings Season

Oil prices have been in a drawdown since they peaked at $123.70 per barrel in March of last year (with an echo peak in June in the $120 per barrel range). As energy investors, we have been fighting two headwinds:

• The Federal Reserve has been shrinking its balance sheet (tightening) since last April. From a peak of $8.96 trillion, it has declined 6%. We have seen since 2008 that the Fed's attempts to shrink its balance sheet (i.e. "taper") are bearish for risk assets. They have also been short lived, and associated with rebounds that are much larger than the amount of reduction, which is why the balance sheet has grown over time and is an order of magnitude larger than it was twenty years ago.
• Releases of oil from the Strategic Petroleum Reserve have averaged about 600,000 barrels per day over the past year. The liquidation of crude oil inventories is unprecedented and will necessarily eventually end.
  

It will be interesting to see what happens when all of the world's economies are fully reopened, there are no more liquidations of SPR or commercial inventory, and the Federal Reserve (together with other central banks) resumes printing instead of tightening. 

Our view is that eventually all three of those factors will be acting as tailwinds and not headwinds, and that when they are it will be bullish for oil. We just do not know when those stars will all align. (Fed Funds futures currently predict that rates are most likely peak this June, although possibly as late as December. If the SPR were to continue selling at a rate of 600k bbl/d, it would be completely exhausted in under two years.)

Since we do not know when an oil bull market will resume, and we also do not know what price oil will sell for over the long term, it is instructive to see what our energy companies are earning now, at recent commodity prices and refining margins. Fourth quarter results can give us a good look at this, and earnings results are out for Suncor, Cenovus, and Marathon. (We are still waiting for Canadian Natural Resources, which does not report results until March.)

Suncor's market capitalization is $45 billion (at a $34 share price) and the enterprise value is $55 billion. They reported earnings [pdf] for the fourth quarter of $2 billion, which means that shares are trading for under six times net (annualized) earnings. Their adjusted funds from operations for the quarter were $3.1 billion, which gives an annualized (Q4) AFFO/EV yield of 23%. 

Suncor claims to have 7 billion barrels of proved and probable reserves, which is an enterprise value of less than $8 per barrel. The PV-10 of their proved and probable reserves was $50 billion at the end of 2021, which was calculated based on the $66.56 average WTI price that year. Keep in mind in addition to the value of the upstream reserves (which are worth almost the entire enterprise value at a lower oil price than today), Suncor also has its refining and marketing operations, which earned $4.2 billion in 2022.

The shareholder returns are also very impressive. Suncor spent $3.7 billion on capital expenditures last year, versus $2.7 billion on debt repayment, $3.8 billion on share repurchases, and $1.9 billion on dividends. The combined amount spend on debt, buybacks, and dividends was $8.4 billion, which is 19% of the current market capitalization. (The shares repurchased during 2022 were equal to 8% of the beginning of year share count.) Suncor said that they expect to increase their share buyback allocation to 75% of "excess funds," meaning whatever is left over after capex of $4 billion and a dividend of $2 billion ($1.53 per share; a 4.5% yield, by the end of the first quarter of 2023. (The other 25% would continue to be spent on debt reduction, until a target of a $6.7 billion "debt floor" is reached.

Cenovus's market capitalization is $36 billion (at an $18.50 share price) and the enterprise value is $39 billion. They reported earnings [pdf] for the fourth quarter of $580 million and $4.8 billion for the full year, which means that shares are trading for 7.5x last year's earnings. Their adjusted funds flow for the fourth quarter was $1.7 billion, which gives an annualized (Q4) AFFO/EV yield of 17%. Cenovus had some issues with third-party pipeline outages during the quarter that impacted their downstream (refining) operations.

According to the company: "at the end of 2022, Cenovus total proved reserves were relatively unchanged at approximately 6.1 billion BOE, while total proved plus probable reserves increased 7% to approximately 8.9 billion BOE." That makes for an enterprise value per barrel of 2P reserves of under $5 per BOE.

Last year's capital allocation and shareholder returns were impressive. They spent $2.7 billion on capital expenditures for the whole year. Meanwhile, they reduced their net debt to $3.2 billion, which was a decline of $4 billion year over year and $740 million from the prior quarter. They spent $667 million on dividends and $1.9 billion on share repurchases (which was enough to buy back 6% of the beginning of year share count). The combined amount spend on debt, buybacks, and dividends was $5.6 billion, which is 16% of the current market capitalization. They think that by the fourth quarter, net debt should be below the "floor" of $3 billion, at which point they would target "100% shareholder returns" using excess free funds flow.

Marathon Oil Corporation's current market capitalization (at a $26.75 share price) is $17 billion and their enterprise value is $20 billion. They reported earnings for the fourth quarter of $525 billion, which means that shares are trading for 8 times annualized earnings. Free cash flow was $763 million for the quarter which is an annualized (Q4) FCF/EV yield of 15%.

They delivered total shareholder returns of $3.0 billion, representing a distribution yield of 17% on the current market capitalization, including $338 million during the fourth quarter. Most of this was done via share repurchases (totaling $2.8 billion), which resulted in a 15% reduction in outstanding shares. They generated approximately $4 billion of free cash flow for the year and the $3 billion which was returned is 75%; higher than Suncor or Cenovus. The 2023 capital budget and guidance is for $2 billion of capex and $2.6 billion of adjusted FCF, assuming $80 oil and $3 natural gas.

It is interesting to compare the results that these three companies had with a competitor, Devon Energy, which also reported earnings this week. Their capital expenditures were up 80% (Q4 2022 versus Q4 2021) but their production was only up 4%. 

It is good to see a shale producer and competitor exhibiting deteriorating economics. This is why we are interested in royalties and resources with front-loaded costs and long reserve life.

Devon has a market capitalization of $42 billion and an enterprise value of $47 billion. Free cash flow for the fourth quarter was $1.1 billion which was the same as the year prior. It is also interesting that Devon's FCF/EV yield (annualized) is only 9%. It goes to show that other investors do not realize how superior royalty investments and long reserve life investments with front-loaded costs will be in an inflationary environment.

Oil Producer Earnings - Q3 2022

Our four oil producers - Suncor, Cenovus, Canadian Natural Resources, and Marathon Oil - have all reported results for the third quarter. (All figures for the Canadian companies are in USD with an 0.73 exchange rate.)

Suncor's market capitalization is $47 billion (at a $35 share price) and the enterprise value is $58 billion. They reported earnings [pdf] of negative $445 million, however there was a non-cash writeoff of $2.5 billion which was necessitated by their buyout of a minority joint venture partner as a cheap price. Their adjusted earnings were $1.87 billion for the quarter, which means that shares are trading for 6 times annualized (Q3) earnings. Adjusted funds from operations for the quarter were $3.3 billion, which gives an annualized (Q3) AFFO/EV yield of 23%. 

Their proved and probable reserves were 5.8 billion barrels as of the end of 2021, so that's an enterprise value of $10 per barrel. The PV-10 of their proved and probable reserves was $50 billion at year-end 2021, which was calculated based on the $66.56 average WTI price last year. That means the present value of the reserves at a much lower oil price than current WTI covers almost all of the current enterprise value. Keep in mind in addition to the value of the upstream reserves, Suncor also has its refining and marketing operations, which generated $1.8 billion of AFFO during the third quarter.

So far this year, Suncor has returned $4.3 billion to shareholders via dividends and repurchases, which is a 12% annualized shareholder yield on the current market capitalization. Net debt has also been reduced by $1.1 billion. This has all been made possible by $8.6 billion of operating cash flow (less $2.7 billion of capex) year-to-date. (Shares outstanding have decreased by 6% ytd and 7.5% over the past twelve months.) Some conference call comments on capital allocation going forward:

We successfully completed an upsized bond repurchase tender that resulted in buying back our debt below face value, and lowering our structural breakeven by nearly $1 per barrel on a WTI basis. These actions keep us on track with our capital allocation framework and move us toward our goal of reducing our net debt and depending on commodity pricing, increasing capital allocation to share buybacks to 75% by the end of Q1 2023. I would now like to move to our progress on our efforts to optimize our asset portfolio towards our core integrated business. As you know, we've initiated a robust process to divest from non-core assets to increase and focus in our portfolio. Recently, I announced the sale of our wind assets for $730 million. And also during the quarter, we closed the sale of our Norway E&P assets. Meanwhile, the process to sell our UK E&P assets continues, and I expect that process to conclude in the coming months. A portion of the proceeds of these non-core asset sales is being used to increase our operated ownership interest in the Fort Hills asset by approximately 21%. This additional interest in Fort Hills demonstrates our confidence in the long-term value of the asset, which is backed up by a detailed assessment by our new and highly experienced mining leadership.

Fort Hills has a cash operating cost of around $19 per barrel. After buying out the 21% working interest stake in that project from Teck Resources, Suncor management did a cash flow projection using a long term oil price forecast of $60 and found that an impairment was justified on that basis.

Cenovus's market capitalization is $40 billion (at a $21 share price) and the enterprise value is $54 billion. They reported earnings [pdf] of $1.2 billion, which means that shares are trading for 8 times annualized (Q3) earnings. Adjusted funds from operations for the quarter were $2.2 billion, which gives an annualized (Q3) AFFO/EV yield of 19%.

The bitumen (oil sands) reserves of Cenovus, alone, were 7.4 billion barrels at the end of 2021 (proved and probable reserves). Producing at a rate of around 620k barrels per day is a quarter of a billion barrels per year, giving you a 30 year reserve life. The enterprise value is about $6 per barrel and that ignores an additional 0.9 billion barrels of oil equivalent of other reserves, plus the refining assets (which have already earned over a billion dollars year to date). 

So far this year, Cenovus has returned $1.8 billion to shareholders via dividends and repurchases, which is a 6% annualized shareholder yield on the current market capitalization. Net debt has been reduced by $3.3 billion, which is much more aggressive debt repayment as a percentage of market cap or enterprise value than Suncor, and explains the lower shareholder yield for Cenovus. This has all been made possible by $6.1 billion of operating cash flow (less $1.75 billion of capex) year-to-date. Some conference call comments on capital allocation going forward:

In accordance with our shareholder returns framework, we've allocated half of Q3 excess free funds flow to shareholder returns. This is over and above our base dividend. We also continued our opportunistic and disciplined approach to share buybacks through the quarter. This resulted in a return of about $660 million to shareholders through the NCIB program. In addition, the Board of Directors has approved a variable dividend of about $220 million, or roughly $0.14 per common share with this variable component, fulfilling our commitment for 50% of excess free funds flow going back to shareholders. The current NCIB program will expire in early November. As we announced earlier, this morning, our Board has approved the application for another NCIB program. It will provide capacity to repurchase approximately 136 million additional common shares over the next year. We also completed a tender transaction in the quarter, repurchasing about $2.8 billion of debt, bringing our total of repurchase notes this year to $4.3 billion. This exercise mitigated refinancing risk for the company until 2027. It also reduced our weighted average coupon rate, and will save about $200 million in annual interest expense going forward. Our net debt reduction was accelerated this quarter by a working capital release, and now sits at about $5.3 billion. And to put things in perspective, we started this year with $9.6 billion in net debt. So that is a reduction of $4.3 billion of net debt in just three quarters.

Management also commented that they view share buybacks as most attractive below $15 and would prefer dividends above a $22 share price - but that is assuming a $60 oil price. That says something about the valuation at the current $21 share price.

Canadian Natural Resource's current market capitalization (at a $60 share price) is $67 billion, and the enterprise value is $76 billion. They reported net earnings of $2.0 billion for the quarter, which means that shares are trading for 8 times annualized earnings. The adjusted funds from operations of $3.8 billion for the quarter is an annualized (Q3) AFFO/EV yield of 20%.

Their proved reserves of liquids at the end of the 2021, net of royalties, were 9 billion barrels, calculated based on a $66 price for WTI. We are paying around $8 per barrel of proved reserves of liquids at the current share and that does not count the 12 trillion cf of natural gas reserves. The PV-10 of proved reserves at the end of 2021, again assuming a $66 oil price and a $3.70 Henry hub natural gas price, was $65 billion. The enterprise value is now 1.17x the present value of the proved reserves at a much lower oil price.

Amazing: "year- to-date, up to and including November 2, 2022, [Canadian Natural Resources] has returned a total of approximately $10.0 billion to shareholders comprised of approximately $4.9 billion in dividends and approximately $5.1 billion in share repurchases." Those figures in CAD; the USD is $7.3 billion of shareholder returns, which is a 13% annualized shareholder yield on the current market capitalization. They have also reduced their net liabilities by $1.5 billion so far this year. This has all been made possible by $10.8 billion of operating cash flow (less $2.8 billion of capex) year-to-date.

Marathon Oil's current market capitalization (at a $31 share price) is $20 billion and their enterprise value is $24 billion.They reported net earnings of $817 billion for the quarter, which means that shares are trading for 6 times annualized earnings. Free cash flow was $1.1 billion for the quarter which is an annualized (Q3) FCF/EV yield of 19%.

So far this year-to-date, Marathon has spent $2.5 billion on share repurchases and $162 million on dividends, for a total of $2.7 billion returned to shareholders, which is an 18% annualized shareholder yield on the current market capitalization. 

We noted after Q2 that their sales volumes had been down 1% year-over-year from 348k boe/d to 343k. However, in the third quarter, their production was 353k boe/d, which was up 3% year-over-year. Capital expenditures were $413 million in Q3 2022 versus $308 million the prior year. Some conference call comments on capital allocation:

As we have consistently highlighted, we believe our return of capital framework is differentiated in our peer space, uniquely calibrated to operating cash flow, not free cash flow, prioritizing our shareholders’ first call on our cash generation. This is especially important in a market characterized by inflationary headwinds and represents a strong commitment to our shareholders. And during the third quarter, I am pleased to announce we further built on our return of capital leadership by setting a new quarterly shareholder distribution record for our company corresponding to over 80% of our CFO and essentially 100% of our free cash flow to equity holders. Total third quarter shareholder distributions amounted to $1.2 billion, translating to an annual distribution yield of around 24%, a yield that’s not just at the top of the E&P peer space, but at the very top of the S&P 500. While we had guided third quarter return of capital to at least 50% of our CFO, due to strong operating and financial performance, our financial strength, including our replenished cash balance and favorable market conditions, including clear value in our stock price, we saw an opportunity to materially step-up the pace of repurchases. We bought back $1.1 billion of stock during the third quarter. The timing of our decision proved beneficial as third quarter buybacks were executed at an average price of around $24 a share, well below current trading levels.

Marathon also announced the acquisition of 130,000 acres in the Eagle Ford for $3 billion:

The transaction is immediately and significantly accretive to Marathon Oil's key financial metrics, expected to drive a 17% increase to 2023 operating cash flow and a 15% increase to free cash flow. The transaction was acquired at approximately 3.4x 2023 EBITDA and a 17% free cash flow yield, accretive relative to Marathon Oil's 2023 stand-alone metrics at the same price deck (4.7x EV/EBITDA, 13% FCF Yield). (Based off 2023 forward curve pricing of $81/WTI, $5.10/HH and $26.50/NGL as of 10/27/22; FCF assumes 15% cash tax rate: Based off 2023 forward curve pricing of $81/WTI, $5.10/HH and $26.50/NGL as of 10/27/22, MRO share price as of 10/27/22, MRO outstanding share count of 635 million, MRO net debt of $2.9 billion as at 9/30/22; FCF assumes 15% cash tax rate.)

Enhances Return of Capital Profile: As the transaction is accretive to Marathon Oil's cash flow profile, it will immediately enhance shareholder distributions, consistent with the Company's transparent Return of Capital Framework that is uniquely driven by operating cash flow and, in a $60/bbl WTI or higher price environment, calls for at least 40% of annual operating cash flow to be returned to equity holders. More specifically, Marathon Oil expects the transaction to increase 2023 shareholder distribution capacity by approximately 17%. Additionally, due to the cash flow accretive nature of the transaction, Marathon Oil expects to raise its quarterly base dividend an additional 11% post transaction close to 10ct/sh. Importantly, for full year 2022, Marathon Oil still expects to meet its objective to return at least 50% of adjusted operating cash flow to shareholders, outperforming its 40% framework minimum.

Marathon Oil expects to fund the transaction with a combination of cash on hand, borrowings on the company's revolving credit facility, and new prepayable debt. The Company does not expect the transaction to meaningfully affect its leverage profile, continuing to expect a net debt to EBITDA ratio of less than one, and coupled with enhanced enterprise scale anticipates positive credit quality implications.

It is really impressive that Marathon disclosed these metrics. I have never seen a company make an acquisition and affirmatively quantify that what they bought is cheaper than their own stock valuation. (It is also impressive that Marathon's own FCF yield is 13% at $81 oil and a $31 share price.)

This Earnings Season Vindicates the Value vs Growth Hypothesis

This quarter's earnings season has been vindicating the "value vs growth" hypothesis. The "growth" companies that have long been considered bulletproof and which were valued very expensively are reporting falling earnings, while value companies that are valued less expensively are turning out to have pricing power and are reporting higher earnings.

Growth
Let's go through some examples, starting with the three gigantic growth disappointments, Facebook, Google, and Amazon. These are important because the "FAAG" stocks dominate the indices and have had a tremendous run for more than a decade with consistently rising earnings and rising multiples that crescendoed last year. (Note: the second "A" in FAAG is Apple, which is arguably a value stock, and notably the only one of the four that Buffett has ever owned.)

Wasteland Capital posted a good analysis of the Facebook quarter. Revenue was down 4% in Q3 2022 vs the year ago quarter, but costs and expenses were up 19%. The result was that EBIT fell 46%, operating margin fell from 36% to 20%, and diluted earnings per share got cut in half to $1.64. 

Facebook is now trading for 15x earnings. Does that mean we should dump our Philip Morris and buy META since the multiple is about the same? Well, what if PM is actually the better business? Because the cash flow numbers for Facebook were even worse, thanks to Zuckerberg's huge investment in the "Metaverse" boondoggle. 

Look at the cash flow statement. For the first nine months of this year, Facebook had net income plus depreciation of $25 billion versus $36 billion the prior year. Capital expenditures this year to date have been $24 billion versus $14 billion. Free cash flow has dropped to nothing. As someone on Twitter pointed out, it "just swung from 50% cash flow margins to 0%, in one year, at scale, with strong market position. Are there any examples in history similar?"

What is also interesting is that the company borrowed money, despite not having free cash flow, to buy back stock. This is like looking at an oil company annual report from 2013. Someone else asked, "What if Zuck knows already that Facebook's core, advertisement based business model is ultimately doomed and that the Metaverse is the only chance to survive?"

At Google, again see Wasteland Capital's post. Revenue in the third quarter was up 6% versus the prior year, but costs were up 18%, resulting in an operating margin decrease from 32% to 25%. Earnings per share fell from $1.40 to $1.06 so it is now trading for 22x earnings. One of the big drivers is that the number of employees grew from 150k a year ago to 187k. And again, even worse is what happened to free cash flow. For the quarter, net income plus depreciation was $18 billion versus $22 billion a year ago. Capex went from $6.8 billion to $7.3 billion.

Wasteland Capital's writeup of Amazon's results is brutal: "Bezos’ China-goods flea-market delivered a steaming pile..." Operating income for the quarter was cut in half from the prior year. North America went from a small profit to a loss. Operating cash flow decreased 27% to $39.7 billion for the trailing twelve months, compared with $54.7 billion for the trailing twelve months ended September 30, 2021. Our preferred metric "Free cash flow less equipment finance leases and principal repayments of all other finance leases and financing obligations" decreased to an outflow of $21.5 billion for the trailing twelve months, compared with an outflow of $3.9 billion for the trailing twelve months ended September 30, 2021.

Investors in growth stocks were double counting - the companies were over-earning and these earnings were being capitalized at high multiples. Now that they are past peak cycle, the earnings are falling and they are being re-rated, and the shares are plunging. The NASDAQ is down 31% year-to-date. (Interestingly, the equal weight S&P 500 is down 14% YTD and SPY is down 19%.)

So those are the big three "growth" examples. We have to put that in quotes now because their earnings are declining. They still have a combined $2.6 trillion market capitalization (down from $5 trillion at the peak!) and collectively they do not generate much cash (thanks to Amazon's cash burn and Facebook's "Metaverse" bet). 

Someday, the ex-growth companies expenses will be slashed, their earnings will bottom, and by then they will undoubtedly trade at cheap multiples. But that may take a long time since Facebook and Google are dual share class corporate governance disasters. And the knock-on effects of those SG&A cuts will ripple far and wide - any prospective investment should be evaluated for such exposure. (It would be interesting to compare what percentage of tech employees use nicotine versus energy sector employees.)

Value
Now that we have surveyed some of the growth wreckage, let us turn to the value results. As we mentioned, these companies are turning out to have pricing power and are reporting higher earnings thanks to various combinations of price increases and higher sales volumes.

Back in August the Biden administration claimed that this summer's refined fuel demand was lower than it had been in July 2020. (When fuel prices spiked in June, the EIA did not publish their data for two weeks because of a "voltage irregularity," then claimed that demand had fallen to below pandemic levels.) We knew that the data was wrong because midstream companies and refiners, like Magellan and Valero, were contradicting it in their Q2 results. Oil was below $100 per barrel for almost all of the third quarter, so it is interesting to see what third quarter reports are saying about demand. From the Valero conference call for Q3:

Q: "When you talk about demand surpassing 2019 levels for gasoline and diesel, is that primarily driven by strengthening your export channels? Is domestic demand in your areas of service equally strong?"

A: "Really, it's the domestic markets and our wholesale volumes have trended considerably higher. We set a wholesale volume record in August. We beat that in September, and we're on pace to beat it again in October. So wholesale volumes continue to trend higher. If you look at the pump market through our wholesale channels of trade, gasoline is trending about 8% above where we were pre-pandemic levels. Diesel volumes are trending about 32% above where we were pre-pandemic levels. So seeing really strong domestic demand through our wholesale channels of trade."

Q: "you talked about bulletproofing your balance sheet in the prior quarter, and you mentioned evaluating further reductions in your prepared remarks. How much lower would you like to get on your leverage"

A: "on the cash side, we're at a $4 billion cash balance, we talked about how, going forward, we like to hold more cash at $3 billion to $4 billion probably on the base level. But if you're looking at potentially higher flat price levels or economic downturn, you maybe want to hold a little bit more. So we bias to the upper end of that. So we're close to a good spot on both of those. On a long-term debt to cap -- net debt to cap, we have a 20% to 30% range that we target. We're at 24.5% now at the end of the third quarter, down from 40% at the highest point toward COVID. So we've been working in the right direction. I'd like to be even lower, you'd like to be at the 20% range [of debt to capital] to give you more financial flexibility going forward"

Q: "a part of that meeting [with the White House] was meant to see if there was any possibility if somebody could start a refinery up and we discuss -- the industry discuss the difficulty in doing that and that was really the main coming ones."

A: "there was consideration for the ability to restart refining capacity that had been shut down. And I think the general sentiment was that, that wasn't going to happen. Of course, we're not in that boat. But I mean, people had very good reasons for making the decisions that they made, and they weren't in a position to unwind those decisions. So, the solution is going to probably have to come from some waving of regulation or just reduction in demand, which we just haven't seen to-date."

Q: "You brought it up as there is obviously a risk of a slowing economic cycle out there. What level would you think about a typical recession impact in terms of fuel demand, recognizing gasoline is already well below what we would call, kind of, a normal environment. [...] I'm just wondering how you think about the typical magnitude impact of a recession on fuel demand."

A: "I guess as the guys have, kind of, gone back and looked at recessionary period in the past, they see their product demand has hit about two times GDP. So whatever GDP assumption you're going to have, you would take twice that on the impact of fuel demand. And as you mentioned, more of that is going to be diesel, less on gasoline. I think there are some unique situations as we head into next year. One, jet demand hasn't fully recovered. And so you'll have a good increase in jet demand as we would anticipate, and then Chinese oil demand has been down 20%. At some point in time, they will come out of the pandemic, and you would expect to see Chinese demand recover. So the combination of both those things is that we would expect, even with the typical recessionary period, you may see year-over-year global oil demand growth."

Valero reported earnings of $2.8 billion, or $7.19 per share, for Q3 2022, compared to $463 million, or $1.13 per share, for Q3 2021. That's less than 5x earnings on an annualized basis. Valero's net income plus depreciation for the year-to-date has been $10.5 billion. Capital expenditures have been $2 billion. With that remaining free cash flow, they spent $2.4 billion repaying debt, $1.2 billion on dividends, and $2.8 billion on share repurchases. Remember, this is only a $50 billion market capitalization company.

A few observations about the conference call excerpts. Oil and product demand is very strong even at current high fuel prices. Management is still depressed even though they are raking in money - they want to keep paying down debt. And no one sees a way to increase capacity in the industry.

We also see evidence of strong demand at Magellan Midstream, which reported results this morning. Their refined product shipments were flat Q3 2022 vs Q3 2021, but the transportation revenue per barrel shipped was up 8.7%. (And refined product shipments are up 4% year-to-date versus the first nine months of 2021, with the revenue per barrel up 3%.)

On a market cap of $11 billion and an enterprise value of $16 billion, Magellan's guidance is for $1.1 billion of distributable cash flow. So far this year, they have distributed $685 million and made $473 million of unit repurchases. (During the third quarter, they bought back 2.7 million units at an average price of about $50 per unit.) Units outstanding are down 3.5% year-to-date and the dividend yield this year has run about 8%. 

Amazingly, the MMP dividend yield was only 4% at the beginning of 2014 when the ten year bond was yielding 3%. The Magellan equity risk premium over its own 2050 note is now 160 bps, which has come down significantly. Of course, we must remember that inflation will make a big difference to the real returns of the debt holders versus the equity holders.

Altria also reported results this morning. The most important thing was that operating income in the smokeable segment (i.e. cigarettes) was up despite a bad volume decrease:

Net revenues decreased 1.6%, primarily driven by lower shipment volume and higher promotional investments, partially offset by higher pricing. Revenues net of excise taxes increased 0.4%. Reported OCI increased 1.4%, primarily driven by higher pricing, partially offset by lower shipment volume, higher promotional investments, higher costs and 2021 NPM Adjustment Items.

Smokeable income for the quarter went from $2.75 billion to $2.79 billion. Oral tobacco went from $405 to $425 million. Total operating income from $2.95 billion to $3.1 billion (5% increase). We've noticed that Altria has been heavily promoting their on! oral nicotine product, and indeed the volumes were up 68% year-over-year. 

Recall from earlier in this post how much money Facebook, Amazon, and Google are spending on capital expenditures - hundreds of billions of dollars over time. As Devin LaSarre points out regarding Altria, its capital expenditures are only a couple hundred million dollars: "unreal how much money this company makes with so little reinvested."

As we know, Altria owns 10% of AB Inbev (BUD), which also reported today. If you click through, you'll notice the pricing power (we have seen this across various branded consumer staples) - volumes up 3.7% but revenue up 12%.

Results from Suncor Energy are not in yet, but they made an interesting announcement:

Suncor Energy today announced that it has agreed to purchase an additional 21.3% working interest in the Fort Hills Project and associated sales and logistics agreements from Teck Resources Limited, for consideration of $1 billion. Upon closing, Suncor's aggregate share in the project will increase to 75.4%. The acquisition will be funded by cash from asset sale processes currently underway and the company remains on track with its previously articulated capital allocation framework.

They had previously announced that they sold their wind and solar assets to a Canadian utility, and that covers much of the cost of this working interest purchase. The one remaining partner in Fort Hills is a French energy company that thinks oil will be obsolete by 2050. It is a great sign that our management is picking up barrels, and hopefully they will buy out the stupid, politically correct French super-major oil company.

Recall what we wrote in our "New Milestones in the Value vs Growth Trade" post.

Further signs that the value vs growth trade is continuing will be redemptions from growth funds (that beget further selling), reversal of the ESG mandates and divestments of value stocks by institutions, insider selling and share issuances to fund losses at growth companies despite the lower prices, and a ripple effect up the growth quality and maturity ladders as the unprofitable growth companies buy less advertising and other services from even the profitable, mature FANGs ("cascading revenue declines"). 

It looks like the Facebook and Google are starting to suffer from the cascading revenue declines. But they must only just be starting, because Amazon Web Services is still holding up. Even Cathie Wood's "ARKK" ETF is still attracting inflows. 

A couple of ways to look at the big cap growth bubble is to chart the performance of the market capitalization weighted S&P 500 (SPY) ETF versus the equal weight S&P 500 (RSP) ETF, or chart the Vanguard IT versus Vanguard Energy.

We are still in the opening innings of the reversal in value versus growth, but today was a big drawdown for growth investors. Do you even hear any of them questioning themselves? From what I can see, they are blaming macro factors and not considering the strategic factor bet.