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Suncor Energy: Profitability, Debt and Operating Efficiency

Determining a company’s financial health is a very important step in making a decision on whether or not to invest or to stay invested. There are many different ways to compute a company’s financial health. In this test, I will be considering Suncor Energy’s (SU) profitability, debt and capital, and operating efficiency. Based on these criteria, we get to see sales, returns, margins, liabilities, assets, returns and turnovers.

All numbers sourced from Morningstar.

Profitability

Profitability is a class of financial metrics used to assess a business’ ability to generate earnings, compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: Net Income, Operating Cash Flow, Return on Assets, and Quality of Earnings. From these four metrics, we will establish if the company is making money, and gauge the quality of the reported profits.

  • Net Income 2009 = $1.146 billion
  • Net Income 2010 = $3.571 billion
  • Net Income 2011 = $4.304 billion

To pass, the company needs to have a positive net income. Suncor Energy passes. In 2011 the company reported a net income of $4.304 billion.

  • Operating Cash Flow 2009 = $1.289 billion
  • Operating Cash Flow 2010 = $4.247 billion
  • Operating Cash Flow 2011 = $7.069 billion

Operating Cash Flow is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

To pass, the company needs to have a positive operating cash flow. Suncor passes.

  1. ROA — Return On Assets = Net Income / Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company’s net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as “return on investment.”

  • Net income growth
    • Net Income 2009 = $1.146 billion
    • Net Income 2010 = $3.571 billion
    • Net Income 2011 = $4.304 billion
  • Total Asset growth
    • Total Assets 2009 = $69.746 billion
    • Total Assets 2010 = $70.169 billion
    • Total Assets 2011 = $74.777 billion
  • ROA — Return On Assets
    • Return On Assets 2009 = 1.64%
    • Return On Assets 2010 = 5.01%
    • Return On Assets 2011 = 5.76%

Over the past three years, Suncor Energy’s ROA has increased from 1.64% to 5.76%. This indicates the company is making money on its assets. As the ROA has increased Suncor Energy Passes.

  1. Quality of Earnings

Quality of Earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. To ensure there are no artificial profits being processed, the operating cash flow must exceed the net income.

2009

  • Operating Cash Flow 2009 = $1.289 billion
  • Net Income 2009 = $1.146 billion

2010

  • Operating Cash Flow 2010 = $4.247 billion
  • Net Income 2010 = $3.571 billion

2011

  • Operating Cash Flow 2011 = $7.069 billion
  • Net Income 2011 = $4.304 billion

Over the past three years the operating cash flow has been higher than the net income. This indicates that the company is not artificially creating profits by accounting anomalies such as inflation of inventory. As operating cash flow exceeds net income all three years, Suncor Energy passes.

Debt and Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

  1. Total Liabilities to Total Assets, or TL/A ratio

TL/A ratio is a metric used to measure a company’s financial risk by determining how much of the company’s assets have been financed by debt.

  • Total Assets
    • Total Assets 2009 = $69.746 billion
    • Total Assets 2010 = $70.169 billion
    • Total Assets 2011 = $74.777 billion
    • Equals an increase of 7.21%
  • Total Liabilities
    • Total Liabilities 2009 = $35.635 billion
    • Total Liabilities 2010 = $33.448 billion
    • Total Liabilities 2011 = $36.177 billion
    • Equals an increase of 1.52%

Over the past three years Suncor Energy’s increase in total Assets was more than the percentage increase of total Liabilities. This indicates that much of the company’s assets have not been financed by debt. Over the past three years the company’s total assets increased by 7.21%, while the total liabilities increased by 1.52%. As the total assets increased more than the total liabilities, Suncor Energy passes.

  1. Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm’s financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current Assets/Current liabilities

  • Current Assets
    • Current Assets 2009 = $8.331 billion
    • Current Assets 2010 = $10.513 billion
    • Current Assets 2011 = $14.124 billion
  • Current liabilities
    • Current liabilities 2009 = $7.848 billion
    • Current liabilities 2010 = $8.526 billion
    • Current liabilities 2011 = $10.310 billion
  • Current Ratio 2009 = 1.06
  • Current Ratio 2010 = 1.23
  • Current Ratio 2011 = 1.37

Over the past three years, Suncor Energy’s current ratio has increased from 1.06 in 2009 to 1.37 in 2011. This indicates that the company has more of the ability to pay off its short term obligations as it did three years ago. As the number is above 1 this indicates that the company would be able to pay off its obligations if they came due at this point.

As Suncor Energy’s current ratio has increased over the past three years, Suncor Energy passes.

Shares Outstanding

  • 2009 Shares Outstanding = 1.211 billion
  • 2010 Shares Outstanding = 1.574 billion
  • 2011 Shares Outstanding = 1.582 billion

To pass, the company’s shares must increase less than by 2% in any one year segment. Between 2009 and 2010 the company’s shares increased by 29.98%, while between 2010 and 2011 the company’s shares increased by 0.51%. As the shares increased by more than 2% in one of the two years, this is a moot point.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

  1. Gross Margin: Gross Income/Sales

The gross profit margin is a measurement of a company’s manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross Margin 2009 = $10.289 billion / $25.480 billion = 40.38%
  • Gross Margin 2010 = $16.185 billion / $36.287 billion = 44.60%
  • Gross Margin 2011 = $20.331 billion / $39.790 billion = 51.10%

Over the past three years, the gross margin has increased from 40.38% to 51.10%. As the margin has increased, this indicates the company has been more efficient in its manufacturing and distribution during the production process. As the gross margin increased, Suncor Energy passes.

  1. Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenues found on a company’s income statement and the denominator shows total assets, which is found on a company’s balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth
    • Revenue 2009 = $25.480 billion
    • Revenue 2010 = $36.287 billion
    • Revenue 2011 = $39.790 billion
    • Equals an increase of 56.16%
  • Total Asset growth
    • Total Assets 2009 = $69.746 billion
    • Total Assets 2010 = $70.169 billion
    • Total Assets 2011 = $74.777 billion
    • Equals an increase of 7.21%

As the revenue growth has exceeded the asset growth, this implies that the company is producing revenue on its assets. Suncor Energy passes.

Based on the nine tests that Suncor Energy received on profitability, debt and capital, and operating efficiency, the company achieved eight passes and a moot point out of nine. This is a excellent grade for financial health.  Overall, the company is showing excellent results regarding its financial health with eight passes and a moot point out of nine.

To read more on Suncor Energy read my article: SU (nyse) – Suncor Energy – Stock Price Target for 2012

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