Suncor bid for Canadian Oil Sands pits promise against results

CALGARY, Alberta (Bloomberg) -- As Canadian Oil Sands Ltd. tries to fend off Suncor Energy Inc.’s C$4.5-billion ($3.2-billion) bid, the latest upset at its only business couldn’t have come at a worse time. 

After missing production targets each year since 2010, CEO Ryan Kubik is trying to convince investors that this time he’ll deliver on what’s been promised. A Dec. 8 production cut at the Syncrude oil-sands project only adds to the performance concerns.

“Performance is a big factor” for shareholders considering whether to sell to Suncor, said Michael Dunn, an analyst at FirstEnergy Capital Corp in Calgary. “This was supposed to be the year when things got better. Instead, they’ve got worse.”

The production cut at Syncrude highlights the challenges Kubik faces as he defends Canadian Oil Sands and its only asset against Suncor, whose market value is more than 12 times larger and which operates additional mines in Alberta, four refineries, almost 1,500 Petro-Canada service stations and oil wells in the North Sea. Extracting bitumen and converting it into crude is increasingly dominated by large, diversified companies like Suncor, Canadian Natural Resources Ltd. and Imperial Oil Ltd.

Kubik is seeking a second chance from shareholders, who have been stung by a 75% drop in the share price since April 2011. Kubik says greater rewards await if the company remains independent. Suncor CEO Steve Williams says his offer for Canadian Oil Sands, the largest owner of the Syncrude oil-sands mine, would allow investors to move beyond the past poor performance.

“If you want to grow in the oil sands, you need a lot of capital and a strong balance sheet to better weather commodity prices,” said Amir Arif, an analyst at Cormark Securities Inc. in Calgary.

Canadian Oil Sands’s patchy record in meeting earnings targets also appears to weaken Kubik’s hand. His company, with fewer than 50 employees, has missed adjusted-earnings-per-share estimates in seven of the past eight quarters. That compares with four out of eight misses for Suncor.

“Whenever Canadian Oil Sands comes out with guidance, the presumption is that it will not be met,” said Randy Ollenberger, an analyst at BMO Capital Markets in Calgary. “When Suncor comes out with guidance, the expectation is that they will meet or beat guidance.”

Suncor is seeking to increase its Syncrude stake to 49% from 12%, which would make it the largest shareholder. The second-largest owner is Exxon Mobil Corp.- affiliate Imperial Oil, which holds 25% and operates Syncrude. The other four owners are Murphy Oil Corp., Sinopec Group, Japan’s MocalEnergy Ltd. and Cnooc Ltd. through its Canadian subsidiary Nexen Energy.

Suncor spokeswoman Sneh Seetal reiterated comments from Williams’s Dec. 15 letter to Canadian Oil Sands shareholders that highlighted the premium they would earn by tendering their shares to Suncor as well as the lower risk of owning shares in a larger, more diversified company.

Share Offer

The struggle will continue into next month after the Alberta Securities Commission ruled that shareholders have until Jan. 4 to tender their stakes. To get control, Suncor needs two-thirds of the stock. Suncor has extended its bid until Jan. 8 and reminded investors on Dec. 15 of its offer of 0.25 Suncor share for each Canadian Oil Sands share.

Kubik aims to turn things around and emphasized the opportunities for shareholders of keeping the company independent. The company will generate C$338 million of free cash flow with operating expenses of about C$37/bbl, he told analysts on a call on Nov. 30 when the budget and outlook for 2016 was released.

“Our shareholders bought Canadian Oil Sands knowing it was levered to the price of oil, has 46 years of reserves and a strong dividend track record,” Kubik said in an emailed response to a request for comment. “The principles on which they made their investment decision remain sound. The new era of lower cost operations is underway.”

Best Hope

The best shareholders can hope for if Canadian Oil Sands remains independent is an improvement in operational reliability that would boost production and cash flow without requiring new capital, Ollenberger said. No analysts give Canadian Oil Sands a buy rating, while 12 say hold the stock and four recommend selling. Suncor has 15 buy ratings, 10 holds and one sell.

Canadian Oil Sands is on track for a fifth straight year of production declines, while cash flow per share over the past 12 months has trailed the 16 largest Canadian oil and gas producers, according to data compiled by Bloomberg. The company also slashed its dividend late last year to 5 cents from 35 cents, while Suncor raised its payout this year to 29 cents from 28.

Canadian Oil Sands, which has C$2 billion in outstanding debt, also is causing bondholders concerns. Moody’s Investors Service placed the company under review for a downgrade. Its currently rated Baa3, one step above non-investment grade.

“When there’s been so many years of underperformance, you can’t bake any enhanced performance into any of the numbers we look at and that’s what has brought us to this negative outlook for them,” said Terry Marshall, a senior V.P. at Moody’s in Canada.