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Barron's new-found infatuation with Suncor Energy Inc. and Canadian Natural Resources Ltd. sounds disturbingly like too many dysfunctional romances we've seen. It's a love affair based too strongly on a naive hope that the companies' unattractive traits, which have turned off other investors, can and will be changed.
The bullish opinion on the two Canadian oil sands heavyweights, contained in an article by Andrew Bary in the latest edition of the influential U.S. business weekly, looked at the battered prices (their shares are down 15 to 20 per cent in the past 12 months) and relatively modest valuations of both stocks, and argued that oil investors should jump on board.
Let's set aside Barron's dubious reputation for making investment calls; it's a running gag on Wall Street that making the cover of Barron's is a contrarian kiss of death for any investing idea, sort of a Sports Illustrated curse for the business community. (An analysis of the magazine's top stock picks last year by investment newsletter The Motley Fool shows the picks actually handily outperformed the market, although Barron's own data over the past several years indicate more mixed results.)
The bigger issue is the list of caveats attached to the Barron's call – including speculation that both companies "could become targets of activist investors, given their valuable asset bases and low share prices." Holding out for some heroic investor to step in and shake value out of a company is hardly a surefire recipe for turning around a stock.
In the case of Suncor, Barron's stronger of its two picks, the article reasonably argues that the company could afford to ramp up its 1.6 per cent dividend yield. Suncor's free cash flow could approach $3-billion (U.S.) this year – which, as BMO Nesbitt Burns analyst Randy Ollenberger pointed out in a recent report, dwarfs Suncor's large-capitalization peers in the North American oil and gas space. Bloomberg predicts that Suncor will raise its dividend by 15 per cent next quarter – or 2 cents a share quarterly, in line with its 2012 increase – but that would still only lift the yield to 1.9 per cent.
Still, the oil sands are a long-term-capital-intensive business, and Suncor has a long-standing preference to reinvest its cash rather than spit it out to shareholders. If investors are counting on a substantial runup in the dividend over the next few years to justify the investing thesis, that's far from certain.
No, the root of the problems plaguing both stocks – and the source for the only serious prospect of a revival of the bull case for them – is the price differential for Canadian heavy oil. West Canada Select crude is nearly $25 (U.S.) a barrel, or 26 per cent, below West Texas intermediate, the North American benchmark, and 40 per cent below North Sea Brent crude, the European benchmark.
As Mr. Bary rightly noted, a return to something closer to the historical spread with WTI – $15 a barrel – would be veritable catnip for the stocks. And, it should be noted, it has narrowed from north of $35 in the past month, so there is some light at the end of the tunnel.
But the key to long-term healthier prices for oil sands crude is new pipelines – Keystone XL in particular – to overcome severe bottlenecks restricting oil sands' access to high-demand markets. Given that the pipeline solutions being discussed haven't even been approved yet, let alone built, this is a very long-term solution to what looks like a chronic pricing problem.
In that light, the Barron's recommendation is really a long-term bet on North America's appetite for oil sands pipelines. And again, a lot of things have to go right over a significant time horizon for this investment call to become a winner.
David Parkinson is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights.
David Parkinson