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Better Buy: Suncor Energy Inc. vs. Sunoco Logistics Partners

By Matthew DiLallo – Apr 18, 2017 at 2:05PM

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The Canadian oil sands leader goes head to head with a soon-to-be pipeline behemoth.

Suncor Energy (SU -0.21%) and Sunoco Logistics Partners (NYSE: SXL) couldn't be more different companies. Suncor is one of the largest oil producers in Canada, which exposes investors to commodity price volatility. Meanwhile, Sunoco Logistics Partners is a low-risk oil pipeline company that gets the bulk of its income from fees.

While those differences would seem to tilt things in favor of Sunoco, that's not the case. That company is in the process of acquiring its gas pipeline-focused sibling, Energy Transfer Partners (ETP), which will create one of the largest energy infrastructure companies in North America. However, that deal will also cause the company's risk profile to rise sharply. That's one of the reasons I think the risk-reward balance of these two companies actually tilts toward Suncor. 

An oil sands production field in Canada.

Image source: Suncor Energy.

Low-risk oil growth

Suncor Energy is one of the more lower-risk oil companies. That's because the company has a top-notch, A-rated balance sheet. Driving that high rating is the company's low leverage metrics of 2.4 times net debt to funds from operations and 28% total debt to capitalization, numbers both well within its conservative targets of less than 3.0 times and 20% to 30%, respectively. Moreover, the company has $3 billion of cash on the balance sheet, which gives it ample capital to finance its growth projects.

Speaking of growth, the company has two major projects nearing completion, which put it on pace to grow output per share by a 10% compound annual rate through 2019, up from 6% compound annual growth from 2012 through 2016. That's worth noting because the company's prior growth fueled meaningful value creation for investors in the recent past. In fact, the company has delivered 24% compound annual dividend growth and 70% total returns over the previous five years, despite a recent brutal stretch for the oil market. That history suggests Suncor should fuel even stronger total returns over the next few years in more normal market conditions. Given its production projections, it's likely to deliver double-digit total annual returns if oil remains where it is, especially when the company pays a pretty solid dividend that currently yields 2.4% and will likely continue growing at a healthy clip. Meanwhile, it has the potential to deliver accelerated returns should oil move higher.

High-risk, high-yield

Sunoco Logistics Partners had been one of the lower-risk pipeline companies thanks to its focus on generating fee-based cash flow, its low leverage ratio, and ample distribution coverage. However, by merging with the deeply indebted Energy Transfer Partners, the company's leverage ratio will balloon to slightly less than 5.0 times, though the company hopes to get it to a more comfortable sub 4.0 level within 12 to 18 months. Meanwhile, the combined company's distribution coverage ratio will slip closer to 1.0 times, which doesn't leave it with too much room for error. That causes some concern that the company's 8.75% current yield might not be on solid ground.

That said, one reason Sunoco Logistics Partners' leverage ratio will balloon is that the combined company has invested $15 billion in growth projects over the past few years. As these projects come online, they should increase cash flow, which would reduce that leverage ratio over time. Further, these projects position to the company to increase its already generous distribution by a low double-digit rate over the near term. However, the company needs to get through its current growth spurt before that payout is back on solid ground. 

Investor takeaway

In Suncor Energy, investors have a high-growth oil company with a top-notch balance sheet, making it a low-risk way to invest in the oil market. Even if oil prices don't budge from here, the company can deliver double-digit total annual returns. Meanwhile, if crude rebounds, there's the potential for accelerated returns thanks to the combination of growing production and margins. 

Sunoco Logistics Partners, on the other hand, carries a bit more risk despite operating a lower-risk pipeline business because its leverage ratio will surge once it swallows up its larger sibling. That said, the company's clearly visible growth profile suggests it can grow into its balance sheet within a year, which would put its generous payout on solid ground.

However, given the elevated risks already associated with investing in energy stocks, I think Suncor Energy is the better buy over Sunoco Logistics Partners. While it might not be as appealing to income investors, the company's total return potential is much more attractive, especially if oil prices rise along with its production. Meanwhile, if the oil market was to start imploding again, Suncor's low costs and rock-solid balance sheet would blunt its fall, whereas Sunoco Logistics' tighter financial metrics could leave it with no choice but to cut its generous payout to gain more breathing room.

Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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