Berkshire invests in Suncor: What does Warren Buffett think?

Warren Buffett (Trades, Portfolio) does not call the Oracle of Omaha for nothing. Several times during his long career, the boss of Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) made huge investments in companies that the rest of the market did not know. Thus, when Berkshire takes a significant stake in a company, it tends to turn heads.

Suncor Energy Inc. (NYSE: SU) is the latest Berkshire game to have attracted market attention. The energy company has been beaten in recent months. February 14, Berkshire disclosed a 0.7% stake.

Do Buffett and his team envision a turnaround?

Second time charm?

This is the second time Berkshire has owned Suncor shares. Buffett took a stake in the Canadian oil and gas company in 2013, but sold the entirety of its position in 2016. It is worth noting that the game has not been particularly successful.

Suncor has really started to recover only in 2017, which means that Berkshire missed the boat on his first attempt. Of course, he thinks it will be different.

Beaten to negotiate territory?

Things have not gone well for Suncor in recent months. In fact, by December 2018, the stock had lost more than 35% of its summer peak of $ 42.55 per share. Since then, he has somewhat recovered, but he was still down 17% from his 52-week high on the Berkshire disclosure date. This implies considerable upside potential on the sole basis of technical analysis.

Suncor has historically traded higher, and its recent retirement can be attributed, at least in part, to global oversupply issues. Maybe that's what got him back on the Buffett radar in the fourth quarter.

Short-term game?

Unlike his reputation as a buy-and-hold investor, Berkshire sometimes played short-term stocks that were crushed by market overreactions. This has even been the case with energy stocks in the past, as the last time oil prices collapsed and industry stocks experienced a vertiginous drop. For example, a portfolio manager from Berkshire entered and exited Kinder Morgan (NYSE: KMI), taking full advantage of the pipeline company's share price following a surprise dividend cut.

Is this a similar situation? Or does Buffett see something more at Suncor than just a chance?

Bet on cost reductions?

Much has changed at Suncor since Berkshire sold its position. More importantly, the company has drastically reduces production costs associated with its oil sands and mining operations. Once upon a time, it was a high-cost producer, forced to close certain operations when crude oil prices fell.

According to his latest presentations, Suncor could likely continue to operate without interruption even with crude prices of about $ 30 a barrel. This is certainly not the cheapest producer, but its transition is a continuous process. Even then, it has already become a much more sustainable business, with the risk of falling global commodity prices being significantly reduced.

Invest in transformation?

We can only guess at the true intent of Buffett – or his portfolio manager – regarding Suncor. But a position of nearly $ 3.8 billion at the current stock price is extremely heavy for a simple short-term turnaround. Based on what we know about Berkshire's investment strategy, this is a bigger investment in the success of Suncor's fairly radical transformation into a lower-cost producer.

In addition, Suncor has both strong long-term reserves and high production capacity. Existing oil sands resources are expected to deplete at a rate of just 1% per year between 2019 and 2023. At 2017 production levels, its current resources are expected to be good for about 36 years. It's a lot of long-term opportunity.

What are the risks?

We see the logic of a long-term investment in Suncor based on its significant reserves and impressive cost reductions that have transformed the company into a much more sustainable business. That said, mining and production activities are cyclical and oil prices have been terribly confusing lately.

More importantly for Suncor is its refining capacity. An in-depth review of the company's financial results reveals that the lion's share of profits actually come from its refining business. The margins are excellent, which is interesting in most cases. However, as a commodity sector, refinery margins rarely last. There may be some delay, but one of the main risks for Suncor is the increase in refining capacity by others.

Verdict

Our interest was certainly stimulated by Berkshire's latest move. We see an attractive long-term value proposition for Suncor through reduced production costs. But that will not be enough to offset the loss of refining margins in the coming years unless it can continue to drive down the costs of extraction.

Overall, we like Suncor, but we do not see an unassailable gap like the one Buffett usually looks for.

Disclosure: No position.

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