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So you want to buy an O&G stock - but which one?



January 06, 2015 – Comments (4) | RELATED TICKERS: SU , XOM , BRK-B

Investors looking to find opportunities in the O&G industry are likely finding themselves a bit overwhelmed right now.  High quality O&G plays like XOM, CVX, COP, and RDS offer safety amidst uncertainty.  Cheaper options such as BP, APA, and LUKOY are trading at historically low valuations, but have quite a few red flags that could steer people away.  If you want to invest in O&G now, how do you choose which investment to take?

One option could be one that I’ve personally taken before:  when you aren’t sure which cheap stock to take, take them all with an ETF.  I’ve been a long time shareholder of the VGT (getting a piece of MSFT, ORCL, CSCO, AAPL – all stocks I really like) and the XLF (getting a piece of cheap stocks like BAC and C in addition to the higher quality stocks like PNC, USB, WFC, and GS).  An option such as the XLE could work.

But there in another option, still. 

Mohnish Pabrai recently said during an interview that he has zero original investment ideas – 100% of his investments are stemmed from cloning (though I’m not sure who he’s cloning with his Horsehead stake).  Original idea or not – profits from investing don’t differentiate.

With that in mind, I recently took a look at the most widely cloned portfolio of all: Berkshire Hathaway.  While most people that track 13-Fs know that Berkshire holds a sizable position in XOM, there really isn’t another sizable O&G play in the entire portfolio - except for a small stake in Suncor Energy (SU).  It’s the 19th largest holding, and comprises less than 1% of the Berkshire stock portfolio.  So is SU a cloning opportunity?  Is this the play on oil stocks that I should be considering?

On the surface, Suncor doesn’t appear to offer too much from an investment perspective, especially when compared to other O&G companies.  The 3% dividend is lower than the supermajor companies.  The ROE is a meager 10%.  It’s trading for book value, but so are a handful of other solid companies.  And to top it off, it’s a play on the Canadian tar sands – a very high cost method of extracting oil.

So why the hell did Berkshire add this to its stock portfolio?  Well, looks can be deceiving.  And that is the case with Suncor.

For starters, Suncor has a lot of proved reserves relative to its market cap

Price to Proved Reserves:

BP: 6.3

COP: 8.7

SU: 8.8

XOM: 15

CVX: 18

But price to proved reserves isn’t even the best metric.  A potentially better metric to consider is not “Price-to-Proved Reserves”, but “Price-to-Cash Generated from Proved Reserves.” 

When SU produces a barrel of oil from their proved reserves, they generate on average about 2x the OCF as the industry average.  It is a common misconception that all tar sands projects are economically challenged and require high oil prices to be economically viable.  For the lost-cost providers (Suncor) this is simply not true.  Over the past 3 years, SU has averaged about $50 in OCF generation per barrel of oil produced.  Exxon, Chevron, Total, Shell, and Conoco average about ½ that amount.

So if you think about Suncor’s oil reserves from a profitability perspective, SU virtually has 2x the reserves (because they generate 2x the cash per barrel of oil) as what they have stated in their annual reports, thanks to their low-cost oil mines.

The life of a good oil mine is decades.  Not years.  While Chevron’s wells generate $25 OCF/barrel oil for a handful of years, Suncor’s mines have the potential to generate $50 OCF/barrel oil for decades.  XOM and CVX have to worry about replenishing new reserves, while Suncor is sitting on 23 years of existing assets.  And while it’s arguable that the capital requirements for mine development are high, only Exxon has converted a higher proportion of OCF into FCF (OCF – CapEx) over the past 5 year; SU frequently generates $14 in free cash flow per barrel of oil - the highest in the industry.  To put it simply, Suncor is great at controlling capital costs.

And to top it off, Suncor is a cannibal.  Suncor has spent nearly $4B over the past 3 years on share buybacks, reducing the number of outstanding shares by over 7%.  The dividend might seem small at 3%, but if you look at total capital returned to shareholders (dividends + buybacks), a completely different story comes to light.

It seems that only Exxon is on par with Suncor from an overall operation and financial perspective.  Oddly enough, Exxon and Suncor are Berkshire’s two primary energy holdings.  There are definitely cheaper companies out there right now, but Exxon and Suncor seem to be best of breed.  So if you’re looking to go where others fear to tread and nibble on some O&G stocks at $50/barrel oil, “clone away” and follow Berkshire.

Long XOM.

4 Comments – Post Your Own

#1) On January 07, 2015 at 1:45 AM, valuemoney (< 20) wrote:

Berkshire also has an indirect stake in IMO via XOM's 70% stake in the company. IMO's market cap is currently around 34 billion. So XOM has roughly 23.5 billion added in there. I added IMO on my Valuemoneygreen caps page around the same time I added XOM. Later to find out that is when Berkshire added XOM to their holdings. But truth be told oil was not trading under $50 at that time. And if I knew it was gonna I probably wouldnt have added either Long term all 3 should be wonderful holdings. Personally I purchase SU a bit ago and sold it at $31.78. I purchased it at $28 and change. I would be willing to purchase it again but would like to wait for a better price. I think it is weird SU, XOM and IMO haven't went down in price a lot more than they have. I don't know though. Commodity driven stocks r always hard to gage. I would think ten years from now oil would be well over a $100 but I couldn't say for sure! Good post btw. Everyone would like to know the bottom in oil stocks including me!!! :)

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#2) On January 07, 2015 at 2:03 AM, valuemoney (< 20) wrote:

Not a bad idea to always go with best in breed or the biggest and baddest horse. Aka WMT KO PEP BRK.A INTC GOOGL MSFT HD HSY IBM XOM VZ AN BDX AAPL FB AMZN MCD BCR LH....ok people get the picture.... The #1's in their space. There is a reason they r number one. Any number ones get cheap enough I am a buyer. Key is the price. I just wish I could pick the exact bottom hehe.

Long IBM btw (and in the red!!!) and long VZ 

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#3) On January 07, 2015 at 9:36 AM, ElCid16 (93.40) wrote:

I think it is weird SU, XOM and IMO haven't went down in price a lot more than they have. 

I wish Exxon got a bit cheaper over the past 2-3 months...would have definitely been my purchase of choice.  But you're right, it really isn't that much cheaper now than it was a year or two ago.

the biggest and baddest horse. Aka WMT KO PEP BRK.A INTC GOOGL MSFT HD HSY IBM XOM VZ AN BDX AAPL FB

INTC, GOOGL, MSFT, IBM, AAPL, FB - all major holdings in the VGT, which also includes those "baddest horses" V and ORCL  :) 

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#4) On January 07, 2015 at 9:37 AM, ElCid16 (93.40) wrote:

And thank you for the info regarding IMO!

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