When Beaten Down is a Bargain

10/30/2008 10:10 am EST

Focus: GLOBAL

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

Gordon Pape, editor of The Canada Report, is bargain-hunting in the Canadian oil sands industry.

Sands giant, Suncor Energy (NYSE: SU), has been hit hard by sinking oil prices. The stock is down more than 50% since our September issue. With that kind of performance, you'd think this was a junior exploration company rather than one of Canada's energy giants with profits in the billions.

Suncor won't report third-quarter results until Oct. 29 and we can expect to see a decline in profits. But the profit fall almost certainly won't be of a magnitude that would justify such a precipitous drop in the share price.

In the first six months of this fiscal year, Suncor reported net earnings of just over $1.5 billion ($1.62 a share, fully diluted), up from $1.2 billion ($1.40 a share) in the same period of 2007 (figures in Canadian dollars). During the first half of this year, the average price of West Texas Intermediate crude was US$110.95 a barrel. It will almost certainly come in below that in the second half, but consider this. In the first half of 2007, the average price was US$61.60. We aren't likely to see an average price for the second half of this year that comes close to that.

As well, Suncor has said it expects its production costs in the last six months of this year to drop significantly. The company said that in the second quarter its average operating cost was $50.85 per barrel "due to higher operating expenses, lower production volumes, and increased third-party bitumen purchases."

However, the company said that it expects its average cost over the year to come in at $35 to $36 a barrel, which suggests a significant improvement to the upside. Looking at these numbers, it appears certain that the third-quarter results will be down from the profit level reached in the second quarter but nowhere near as bad as the drop in the share price seems to imply. We have also seen that Suncor can make a lot of money even at much lower oil prices than we have right now.

This is a buying opportunity for investors with a longer time horizon. The world may need less oil for a while but demand will eventually recover. In the short term it is possible that Suncor stock could fall to the $15- $20 range if the price of crude continues to drop so that's the risk you take in buying now. But if you have an adequate time horizon, it's a risk worth taking.

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