Suncor Energy Inc. SU-T set clear performance targets this summer in the face of an activist investor campaign. The fate of its Petro-Canada division rests on just how quickly the oil and gas company wants to reach those goals.
On Tuesday, Suncor executives are scheduled to stage their first investor day since reaching an agreement in July with hedge fund Elliott Investment Management LP. The settlement saw the company welcome three new board members, pledge to address operational issues and consider selling Petro-Canada and its 1,800 gas stations. Last month, Suncor promised to reveal plans for the division, which analysts estimate could fetch up to $10-billion, at Tuesday’s session.
Going into the big reveal on Petro-Canada’s future, Suncor interim chief executive officer Kris Smith has made a number of investor-friendly moves. Since taking over from predecessor Mark Little in July, Mr. Smith has narrowed the company’s focus by selling wind and solar power plants for $730-million, spending $1-billion to boost its interest in an oil sands project and raising share dividends by 11 per cent.
Mr. Smith is also making Suncor a safer place to work, no small achievement at a company that experienced far more workplace fatalities than peers in recent years. In a report, analyst Greg Pardy at RBC Capital Markets said Suncor has reduced the number of contractors on its sites – outside employees were involved in numerous accidents – and has introduced collision-avoidance technology on more than 1,000 mining vehicles. Mr. Pardy said with these operational improvements, Mr. Smith “is someone we could see becoming its permanent CEO.”
What will Mr. Smith do with Petro-Canada, a division the former lawyer ran for nine of his 22 years at the company?
Suncor is going back to its roots as a pure oil sands company
Well, here’s what he’s highly unlikely to announce: the sale of the chain to a rival such as Alimentation Couche-Tard Inc. ATD-T or Parkland Corp PKI-T. While Suncor management has been tight-lipped during the Petro-Canada review, investment banking sources working for potential buyers say Suncor made no attempt this fall to shop the entire division.
It is quite possible Suncor announces plans to spin out a stake in Petro-Canada, in the form of an initial public offering. The move would raise significant capital – it’s easy to envision a $1-billion market debut – to speed debt repayment and boost share buybacks. All these moves would draw praise from Elliott.
The question for Mr. Smith and the Suncor board is how quickly to move. As of September, the company had a manageable $14.6-billon of debt. One of Suncor’s clearly defined strategies is to allocate half of its excess cash to paying down loans, while the other half is earmarked for buying back its own stock.
When Suncor’s debt falls to $12-billion – currently forecast to happen in a year’s time – the company pledged it will move to spending 75 per cent of excess cash on share repurchases. Once debt declines to $9-billion, the company will send 100 per cent of excess cash to investors, via buybacks. The faster Suncor hits those thresholds, the happier Elliott will be.
That’s the backdrop ahead of Mr. Smith taking the stage on Tuesday. The CEO can credibly stand before investors and say Suncor is taking a slow and steady approach, holding on to 100 per cent of Petro-Canada because it is an important part of its electric-vehicle-charging strategy. By next fall, the company will have paid down debt and be in a position to increase the percentage of cash devoted to buybacks.
Or Mr. Smith could announce plans to turbocharge cash generation by selling a portion of Petro-Canada in an IPO, aggressively knocking back debt and speeding up buybacks.
While the IPO market is moribund, there is strong investor interest in recession-resistant retailers such as gas stations and convenience stores. Couche-Tard is a top performing stock that trades at 18 times the company’s earnings per share. Rival Murphy USA Inc., roughly the same size as Petro-Canada, sports a US$6.8-billion market capitalization and a stock that trades at 11 times earnings.
Suncor stock currently trades at 8.5 times earnings. If the company can sell Petro-Canada shares at a double-digit earnings multiple and use the cash to buy back its own stock at a far lower P/E ratio, that’s a winning trade for Mr. Smith.
Suncor is now on the road to better performance and increased share repurchases. On Tuesday, we will find out how quickly Mr. Smith plans to travel.