Is Suncor a Buy for its 4.2% Dividend?

Suncor Energy (TSX:SU) has a 4.2% yield. Is it a buy?

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Suncor Energy (TSX:SU) has been one of the best-performing large-cap TSX stocks this year. Up 24.28% year to date, not counting dividends, it has handily outperformed the broader index. Counting dividends, it’s up closer to 27% — far ahead of the index.

The question is, how long can all this last? Energy prices have been extremely volatile this year. When oil prices recently took a leg down to the mid-60s, Suncor stock barely reacted. If we head back to such levels, then Suncor may be overvalued today. In this article, I will explore various factors impacting the valuation of Suncor stock so you can decide whether it’s a good addition to your portfolio.

Oil prices

The biggest factor impacting Suncor’s future performance by far is oil prices. Suncor mainly sells crude oil and gasoline, so the prices of these commodities impact its profitability.

On the whole, there are many signs indicating that oil prices will be healthy going forward. OPEC output is relatively low, curtailing supply. At the same time, demand for oil continues to inch up little by little each year. Over the long term, renewable energy and nuclear challenge oil. However, these factors probably won’t be enough to kill the demand for oil in the next five years.

Recent earnings

Next, we need to look at Suncor’s earnings performance. In its most recent quarter, Suncor beat analyst estimates on revenue as well as earnings per share (EPS), delivering the following metrics:

  • $13.04 billion in revenue, up 11.2%
  • $3.4 billion in funds from operations
  • $1.4 billion in free funds flow
  • $3.4 billion in funds from operations, up 30%
  • $3.8 billion in cash from operations, up 35%
  • $2.05 billion in net debt reduction

The trends in Suncor’s debt and cash flows are undeniably positive, indicating that the company has many profitable quarters ahead of it if oil prices hold up.

Growth and profitability

Two factors that Suncor Energy stock has going for it right now are growth and profitability. In the trailing three-year period, SU stock grew at the following compounded annual (CAGR) rates:

  • Revenue: 18%
  • Operating income: 96%
  • Net income: 80%
  • Free cash flow: 27%

Likewise, the company boasted the following profitability metrics in the trailing 12-month period:

  • Gross margin: 58%
  • Earnings before interest and taxes margin: 19.4%
  • Net income margin: 14.9%
  • Free cash flow margin: 15%

So, Suncor is profitable and growing, and as long as oil prices remain reasonably high, this should continue.

Valuation

Last but not least, we have valuation multiples. At today’s prices, SU stock trades at the following:

  • 9.6 times earnings
  • 1.34 times sales
  • 1.5 times book value
  • 4.4 times operating cash flow

On the whole, Suncor is cheap compared to last year’s earnings. And if oil prices remain healthy, it’s cheap compared to next year’s earnings, too.

Foolish takeaway

On the whole, I think Suncor is worth the investment today. I bought some shares Yesterday, just before writing this article, so I’m putting my money where my mouth is. My main intention with Suncor was to hedge against the cost-side oil price exposure in an Air Canada position I’d purchased earlier, but I’d be comfortable holding SU on its own merits, too. I think it will do reasonably well going forward.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has no position in any of the 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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