Credit Suisse believes Suncor Energy Inc. (NYSE:SU) could part with its retail business by selling its gas stations for a pre-tax profit of around 9.6 billion Canadian dollars ($7.39 billion) to CA$11.2 billion.
According to Manav Gupta, one of Credit Suisse's analysts, there is "a possibility that like Marathon Petroleum, Suncor will end up selling its retail business." He added, "We believe the primary use of proceeds could be to support higher shareholder returns as was the case with Marathon's Speedway sale proceeds."
I do not think a sale of the business would be a good move. I also believe Suncor's stock is overvalued.
Why Suncor's retail business holds value
Suncor's retail business provides full vertical integration, allowing the company to control the entire value chain. Whenever a company controls its entire value chain, it does not need to bargain with supplies, resulting in pricing power.
The company's existing business model provides testimony of how it is managed to achieve economies of scale and hold down pricing power. For instance, Suncor is operating at a gross profit margin of 48.76%.
My valuation concerns with Suncor's stock is multifactorial. First, the stock is trading at 1.52 times its book value, implying the market has overhyped the asset. Additionally, it is uncertain whether peak inflation has been reached; however, if inflation tapers down, much of the company's book value could recede abruptly as oil and gas prices are extremely elastic.
The second factor I am worried about is the company's dividend payout to residual trade-off. Suncor's 38% dividend payout ratio and 3.88% dividend yield are certainly lucrative if you are interested in total returns. Nonetheless, when dividend payouts drift too high, they tend to slow down the underlying company's growth and, in turn, its stock price's growth trajectory.
Lastly, Suncor's price-earnings ratio is not low by any means. In fact, the company's price-earnings and PEG ratios imply its last four quarters' earnings per share growth does not justify its current stock price. Therefore, Suncor is possibly overpriced.
Oil and gas stocks are hot picks in inflationary environments like we are seeing. Many analysts believe oil and gas could experience a multiyear growth trajectory as supply concerns persist. However, based on relative valuation metrics, Suncor is significantly overvalued, which makes it a risky bet.
Furthermore, Suncor's sale of its retail business could hinder its long-term progress as the abandonment of its vertically integrated business would likely erode its pricing power.
This article first appeared on GuruFocus.