John Molson School of Business, Concordia
ACCO 310: Section AA
Fall 2012

Annual Report Project
Husky Energy Inc.
Vs.
Suncor Energy Inc.

Presented by:
Brittany Weekes - 6323677
Victoria Zillic - 9235477
Kwun Chung - 6290337
Ye Zhang - 5894352

Submitted to: Professor M. Sellors
Date: November 27, 2012
Table of Contents Introduction 1 The Companies 2 Husky Energy Inc. 2 Investments 2 Suncor Energy Inc. 3 Investments 3 The Industry 4 Stock Performance 6 Ratio Analysis 8 Risk Factors 10 Commodity price risk 10 Regulatory risk 10 Sovereign risk 11 Earnings per Share (EPS) 12 Conclusion 14 References 16 Appendices 17 Appendix 1: Husky's Production - December 31st, 2011 17 Appendix 2: Suncor's Production – December 31st, 2011 18 Appendix 3: Ratio Interpretation 19 Appendix 4: Husky’s Basic EPS – December 31st, 2011 20 Appendix 5: Suncor’s Basic EPS – December 31st, 2011 20 Appendix 6: Husky's Financials 21 Appendix 7: Suncor's Financials 24

Introduction The purpose of this report is to carry out a financial analysis on Husky Energy Inc. and Suncor Energy Inc, to determine which of these two companies make up the appropriate energy-related exposure for our client’s stock portfolio. Thus, a financial analysis evaluation will be presented for the above mentioned companies as well as a reasoned investment recommendation to support our proposal. Acting as financial analysts, our team will reveal the macro and micro economic conditions along with the company's fundamentals, sector, and industry recommendations (Investopedia, 2012). Throughout the body of this paper, these companies will be assessed based on their overall appeal in terms of industry, primary businesses activities, and financial performance over the last three years. In order to apply our knowledge of course material and develop our analytical research, we will be evaluating the recent trends in the stock’s performance and earnings per shares. In addition we will be performing a ratio analysis as a means of comparing the companies’ profitability, liquidity and solvency. Upon completion of this detailed analysis, we are confident that we will provide be providing our client with a well-informed recommendation.

The Companies
Husky Energy Inc. Husky Energy Inc. is one of Canada’s largest energy company’s and is primarily involved in upstream, midstream, and downstream operations. The company’s primarily operations are located in Western Canada. Husky’s main activities are centered around the production of conventional oil, natural gas, natural gas liquids, and bitumen. The North American operations consist of all three segments; upstream, midstream and downstream. The upstream operations consist of exploration and development activities, while the midstream and downstream segments involve the marketing and refining of their products. Husky also operates pipelines and storage facilities in Western Canada.
Table 1: HSE's market capitalization Market Capitalization | $26.9 billion | Annual Sales (2011) | $24.5 billion | Annual Income (2011) | $2.2 billion | Geographical Locations | Canada, United States, Asia Pacific, Other International | Investments The bitumen division currently represents a small portion of the company’s total production. There are several growth projects that are underway in the province of Alberta, which consist of expanding the total production volume of the Bitumen segment. Projects in Alberta mainly consist of drilling and field development of their recently acquire oil sand reserves. Other domestic investments underway in Canada include offshore expansion in the Newfoundland Basins. Current development projects in the Atlantic region comprise of well project to identify the significance of those reserves. Husky’s international investments include two offshore natural gas projects in the Asian-Pacific region; China and Indonesia. Production for the Asian-Pacific project is set to start in 2014. Husky is also in the process of identifying potential wells in Greenland’s west coast. Current investments in the midstream and downstream segments include the construction of a barrel tank in Alberta, and refinery upgrades in Ohio.
Suncor Energy Inc. Suncor Energy is a leading energy company in Canada currently operating on an international scale. Suncor’s primary business segments consist of the exploration, production, refinement and marketing of crude oil, natural gas, and bitumen. Recently, the company has expanded its operations to include a renewable energy portfolio. Suncor currently operates six wind power facilities and an Ethanol plant in Ontario. Despite this expansion, the Oil Sands represent Suncor’s major business segment.
Table 2: SU's market capitalization Market Capitalization | $51.9 billion | Annual Sales (2011) | $39.3 billion | Annual Income (2011) | $4.3 billion | Geographical Locations | Canada, United States, United Kingdom, Libya, Syria |
Investments
Technological investments have commenced in the Oil sands operations in Northern Alberta to reduce the land reclamation process. Other investments in the Oil Sand segments include the integration of new projects, along with upgrades to current projects. International investments include a joint venture with Nexen Inc, in an offshore crude oil drilling project in the North Sea in the United Kingdom. Nexen Inc, is an upstream oil and gas company, primarily developing resources in UK North Sea (nexeninc.com). This project is set to start production in late 2014. Two additional wind power projects are underway in Southern Alberta and Southwestern Ontario.

The Industry The energy sector can be divided into three subsectors; Natural gas, Crude oil and Oil sands. Each subsector has its own characteristics, and may not necessarily be equally attractive to an investor. The table below provides an overview of the issues currently facing each subsector. It can be noted from the table below, that all subsectors are facing the challenge of finding an export market.
Table 3: Industry sector issues Natural Gas Sector | Crude Oil Sector | Oils Sands Sector | The industry is facing a reduced demand from its major importer, the United States, due to their own shale gas boom | Oil reserves are becoming increasingly harder to extract and are being found in undesirable locations with greater extraction risk. | Environmental concerns regarding the level of greenhouse gas emission | In comparison with other countries, Canada can provide a secure supply of natural gas and can allow emerging markets to diversify their supply. | Expandable tubular technology has enabled producers to extract oil from reserves previously not economic. (Aladeitan et al) | The European Union has mentioned their intension to label oil sands as highly polluting | Few mediums currently exist to export natural gas to the Asian-Pacific region where demand remains strong. | Crude oil is increasingly being substituted with natural gas. | Oil sands have become increasingly attractive because of the uncertainty and high risk involved with offshore drilling. | Recent investments in the Canadian natural gas industry by Asian countries may suggest their future need to export to their country. | Access to the United States and the West Coast needs to be increased to maximize operations. | Success of oil sand production is dependent on finding export market | | | Growing energy demand and declining conventional oil supply are turning unconventional supply more economical feasible. |
Figure 2: Suncor's Production Sectors for the year 2011
Figure 1: Husky's Production Sectors for the year 2011

As shown in Figures 1 and 2, the two companies’ production levels of each subsector are significantly different. SU’s main production stems from its Oil Sands segment whereas HU’s main production is from its Crude oil segment. As a result, certain issues within the industry may impact one company more than the other. For example, the ban of fuel retrieved from the oil sands, within the European Union, would be likely to have heavier effects of SU operation, as 62% of its production is sustained form the oil sands. Consequentially HSE has greater exposure to the issues facing the natural gas and crude oil sector; which comprises 92% of their total production. The viability of each segment depends on the industry’s ability to overcome the issues, mentioned in table 3. In particular, overcoming such issues requires technological developments and hefty investments. Based on this, the best energy company to invest in would be one with a diversification of the three subsectors and that is proactively investing in new technologies.

Stock Performance Suncor is Canada’s premier integrated energy company, the fifth largest North American energy (Suncor Energy Inc). Suncor trades both on the TSX and NYSE (stock symbol SU). Husky, also one of Canada’s largest integrated energy companies (Husky Energy Inc) trades only in the TSX (stock Symbol HSE). Only the TSX stocks of SU are considered in the evaluation of both companies stock performance. Table 4, below, demonstrates the stock performance of both companies over the last 3 years, using the 2008 closing price as the basis of comparison. (Finance.yahoo.com)
Table 4: 3-year 9-month Stock Analysis | AverageGrowth | On September 30 | On December 31 | | | 2012 | 2011 | 2010 | 2009 | 2008 | HSEStock Price | | 26.42 | 24.55 | 26.55 | 30.08 | 30.87 | LKN % Growth | -4% | 86% | 80% | 86% | 97% | 100% | SUStock Price | | 32.34 | 29.38 | 38.28 | 37.21 | 23.72 | % Growth | 10% | 136% | 124% | 161% | 157% | 100% | S&P/TSX Composite Index | | 12,318 | 11,955 | 13,443 | 11,746 | 8,988 | % Growth | 10% | 137% | 133% | 150% | 131% | 100% |

Based on this 3-year analysis, only Suncor was able to outperform the composite index. Specifically, Suncor outperformed the composite index in 2009 and 2010, and remained fairly close to the index in the following years. On the other hand, HSE's growth average was considerably lower than the composite index. During that same period, Suncor maintained a 10 % increase in its annual stock price, in contrast to Husky’s 4% annual decease. Legend: | Suncor Energy, Inc. | Husky Energy, Inc. | S&P/TSX Composite Index |
Graph 1: Comparison of the index with HSE and SU's Stock Performance

Graph 1 (Finance.yahoo.com) demonstrates the results of the economic slowdown in 2009. Based on this chart, we notice that both companies' stocks were relatively close to the index during this time period. The approval of Suncor’s Petro Canada merge allowed Suncor to overcome the economic slowdown and outperform Husky and the index. While, Husky’s minor increase in stock performance between 2009 and 2012 was the result of modified projects coupled with the intensification of drilling developments.
From 2011 and onwards, there are a few instances where Suncor outperformed against the index. Suncor’s inability to outperform the index was largely due to the political instabilities in their Libyan and Syrian operations. Operations in Libya and Syria account for approximately 9% of SU’s total production. These political instabilities persisted throughout 2012. SU’s operations in Libya have gradually resumed, where as operation in Syria have been indefinitely suspended. This trend illustrates Suncor’s volatile performance and Husky’s steady performance throughout the 3-year period.
Ratio Analysis Investors perform a ratio analysis to determine and interpret relationships between elements of financial statements as a means of evaluating a firm’s overall performance. The use of financial ratios is valuable because it allows investors to identify trends and make assumptions about a firm’s future performance prior to investing. Although, financial ratios provided a meaningful understanding of a firm’s position, they are based entirely on the data found in the financial statements. Therefore, any misrepresentations in the financial statements of a company may display more favorable results in the calculated ratios. To compare the financial performance of Husky and Suncor, the liquidity, profitability and solvency ratios will be examined.
Table 5: Comparative ratio analysis of HSE and SU for the year ended December 31, 2011 Ratio | HSE | SU | Current | 1.61 | 1.37 | Total Liabilities to Total Assets | 45% | 48% | Return on Assets | 8% | 6% | Return on Equity | 11.8% | 13.8% | Times Interest Earned | 15.55 times | 10.52 times | Price-Earnings | 10.23 times | 10.72 times | Dividend Yield | 5% | 1% |

With respect to the current ratio, HSE appears to be better able to meet current obligations and finance their assets through equity. This may be of particular interest to creditors. Creditors use the current ratio to determine whether to make short term loans (Readyratios.com). However, SU’s higher leverage reveals it has the ability to deliver higher returns and losses. This is particularly important because returns on assets and equity are critical indicators of performance in this type of capitally extensive industry. HSE's higher ROA indicates that it is more efficiently using its assets to generate earnings whereas SU’s higher ROE illustrates it superior ability to generate earnings from its shareholders' investments. SU more efficiently utilizes debt to foster future growth projects. HSE provides considerably higher dividend yields (1.20 per share) which is relative to its lower market share (26.42 per share). Overall, the ratios highlight both HSE and SU have a reasonably strong financial positions within the industry. HSE is more attractive to investors looking for secure dividend payout, whereas SU is more appealing to riskier investor looking to higher returns.

Risk Factors
Commodity rice risk The oil and gas industry has forever been an industry with a lot of uncertainty, due to factors beyond the industry’s control. Commodity prices are heavily influenced by the global economic health and growth. The supply and demand for oil and natural gas can be influenced by several factors by such as natural disasters, weather conditions, OPEC members, and several other factors. As a result, Husky and Suncor’s financial performance greatly depends on the commodity price of the products produced in their upstream and downstream segments. Given the wide price fluctuations in recent years, SU and HSE can expect continued volatility in commodity prices. The economic feasibility of a reserve is centered on the commodity price. As oil reserves are becoming more costly to extract, a decrease in price can temporarily shut down production and delay future projects for both companies. In particular, the market for heavy crude oil is more susceptible to changes in supply and demand, primarily due to its lower quality and higher cost of transportation (Suncor Inc.). Limitations, disruptions, and the uncertainty of a planned pipeline project may further impact the price. Changes in price realizations for crude oil may negatively affect HSE’s crude oil segment and SU’s bitumen segment.
Regulatory risk Regulatory risks have comparable material adverse affects on all players in the oil and gas industry. Rules and regulations within this sector are comprised of and not limited to; royalties, production rates, restrictions, safety performance, and environmental protection controls. The companies’ ability to maintain inventory levels heavily depends on its ability to fulfill the necessary obligations to obtain exploration and development permits. Recent events within the industry have made way for more stringent regulations, income taxes and royalties. As the result of the oil spill in the Gulf of Mexico, the United States has implemented stricter regulations for offshore drilling (Husky Energy Inc.). The impact of changes in regulations may increase the companies’ capital and operating expenditure to sustain operations as well their legal liability. The implication of any new regulations and restrictions adopted by countries and states where neither, HSE or SU actively market, may be consequential. Such implications may create barriers to export markets. Furthermore, all changes in legislative regulations have a direct impact on the companies’ financial position. Both HSE and SU have repeatedly experienced the impact of such change.
Sovereign risk HSE and SU both currently operate in a number of developed and developing countries with different political systems. Foreign operations are subject to a number of risks. Due to political instability, foreign operations may result in revenue loss, and may sustain further costs to safeguard the related assets. Moreover, economic and legal sanctions may be imposed. In 2011 SU’s operation in Libya and Syria were suspended due to the political unrest and the sanctions imposed by international governments. Both HSE and SU must comply with anti-corruption laws while operating in foreign countries, and are subject to the countries jurisdictions. Overall, HSE and SU are exposed to similar risks that may materially impact their financial condition. Both companies’ are exposed to risks beyond their control. Despite the companies’ efforts to mitigate the impacts of the above-mentioned risks, they are faced with a high degree of uncertainty. We conclude that neither company faces more risks than the other.

Earnings per Share (EPS) Earnings per share represent the net earnings allocated to each common share. EPS provides investors with an indication of the organizations' profitability. Companies with complex capital structures must report both basic and diluted EPS (Investopedia.com). Diluted EPS is calculated based on the assumption that all convertible shares have been converted into common shares. Diluted EPS provides investors with more meaningful representation. For the purpose of this report, we will be comparing only the basic EPS from HSE and SU. Basis EPS is computed by dividing net earnings; less any prefer dividends by the number of common shares outstanding. (Intermediate Accounting)
Table 6: HSE's 3-year EPS Growth Analysis for the year ended December 31, 2011 Husky Energy (HSE) | AverageGrowth | 2011 | 2010 | 2009 | 2008 | Number of WACS outstanding (millions) | | 924.07 | 853 | 850 | 849.20 | Basic EPS | | 2.40 | 1.11 | 1.67 | 4.42 | Growth Rate (EPS) | -15% | 54% | 25% | 38% | 100% |

Table 7: SU's 3-year EPS Growth Analysis for the year ended December 31, 2011 Suncor Energy (SU) | AverageGrowth | 2011 | 2010 | 2009 | 2008 | Number of WACS outstanding (millions) | | 1,571 | 1,562 | 1,198 | 932 | Basic EPS | | 2.74 | 2.45 | 0.96 | 2.29 | Growth Rate (EPS) | 7% | 120% | 107% | 42% | 100% |
Based on the data in tables 6 and 7, SU’s three-year average growth exceeds that of HSE. In comparing the average growth on a yearly basis, the trends demonstrate signs of role reversal. Between 2008 and 2009, HSE had considerably higher EPS. Throughout 2010 and 2011, SU’s EPS marginal surpassed that of HU. Investors cannot base their decision merely on the EPS ratio. As shown in table 7, SU’s outstanding common shares have been extensively higher than HSE during the 4-year period. Comparing EPS among companies fails to take into consideration the variation in the number of outstanding common shares and the companies’ capital structure. A higher EPS does not indicate a better overall performance. Investors must take into consideration other factors when evaluating the EPS of a company such as net earnings, return on equity, and dividends to better assess the financial position of a company. We therefore conclude that neither company is better off than the other concerning the EPS.

Conclusion This report analyzed the financial stability of two companies currently operating in the oil industry (HSE and SU) in order to make a recommendation to our investor concerning the addition of a new investment to their current portfolio. We have determined the best company for our client to invest in, is Suncor Energy Inc. The evidence gathered from the stock performance analysis supports why Suncor is the stronger player when compared to Husky. Despite the economic slowdown, SU was still able to outperform the industry index. Additionally, they maintained an annual stock price increase of 10% consistently for 3 years and are aligning themselves to continue with this trend. Furthermore, Suncor's merge with Petro-Canada supported this increase. Over the recent years, SU has been exceeding the industry norm. However, it is important to note that due to some political instabilities SU is facing, HSE may appear to be superior. Nonetheless, Suncor has proven its capability to remain a leader. Suncor has proven its capability to remain a leader. Based on the information acquired by the financial ratios, both companies are superior in different areas. HSE has a competitive advantage concerning the current ratio. However, SU has the ability to deliver higher returns than losses, which is more valuable to investors and more favorable. Overall, the ratios emphasize that both HSE and SU have a strong financial position in the industry. However, each firm conveys perspectives for different investment strategies. HSE is more attractive to investors looking for a secure dividend payout, whereas SU is more appealing to riskier investors looking for high returns. In terms of the risk factors, they are uncontrollable, especially when considering external risks. The oil industry, in particular, faces some risks such as price commodity, regulatory, and sovereign on a regular basis. As a result, HSE and SU are rendering similar issues. Sovereign risk recently affected Suncor causing them to suspend operations in Libya and Syria, but this does not mean that HSE cannot be impinged likewise. Despite the companies' efforts to ease the effects of the aforementioned risks, they are faced with a high degree of uncertainty – where anything can happen at any given point in time. For the past 3 years, SU's average growth rate exceeded that of HSE, 7% and -15% respectively. However, HSE's EPS has been higher. EPS is a financial characteristic that cannot be evaluated by the naked eye. Additional information such as share capital must be considered. As a result, we determined each company is still not outperforming the other. Overall, both companies can be considered as a safe investment - they are both leaders in this competitive and solid market. Risks will always be a factor due to the industry that these firms operate in. Our recommendation to our client would be Suncor Energy Inc. Their success in the past 3 years is enough evidence that this company is strong and healthy. Nonetheless, every investor has different tastes and preferences, therefore the company that is invested in, depends entirely on the information they believe to be most important.

References
About.com. Debt to Asset Ratio & Price Earning Ratio. Peavler, Rosemary. 2012.
Deloitte.com. Oil & Gas Reality Check. 2006.
Finance.Yahoo.com. Historical Prices of HSE.TO. and SU.TO.& Interactive Charts. 2012, November 19.
Globaljournals.org. Expendable Tubular Technologies “Technology Gaps and The Way Forward”. December, 2011.
Husky Energy. Dividend Information. 2012.
Investopeida.com. Current Ratio, ROA, ROE, TIE, EPS & Dividend Yield. 2012.
Intermediate Accounting (9th Canadian ed.). p. 175-176. Kieso, Donald E., Weygandt, Jerry J., Warfield, Terry D., Young Nicola M., & Wiecek, Irene M., 2010. kpmg.com. Shale Gas-A Global Perspective. 2011.
Nexeninc.com. Joint Venture.2012.
Nrcan.gc.ca. Canadian Crude Oil, Natural Gas and Petroleum Products: Review of 2009 & Outlook to 2030. Petroleum Resources Branch Energy Sector. May 2011.
Oilprice. com. Despite Huge Resources Only a Small Amount of Oil is Recoverable. Tverberg, Gail. March 02, 2011.
Readyratio.com. Current Ratio. 2012.
Reuters.com. EU tar sands Fight Not Over, Experts at Stalemate. Lewis, Barbara. February 23, 2012. http://www.contrarian-investor.com/crude-oil.html. Crude Oil. 2009. http://www.ey.com/Publication/vwLUAssets/Rising-to_new_challenges/%24FILE/Rising%20to%20new%20challenges.pdf. Rising to New Challenges in the Face of Global Demand: Liquefied Natural Gas in Canada. Ernst & Young. 2012.

Appendices
Appendix 1: Husky's Production - December 31st, 2011 Oil Sands/Bitumen | 24,700 | 7.9% | Crude Oil (includes NGL) | 186,600 | 60% | Natural Gas | 101,200 | 32% | Total production | 312,500 | 100% |

Appendix 2: Suncor's Production – December 31st, 2011 Oil Sands BOE/D | 339,300 | 62% | Crude Oil BOE/D | 67,824 | 12.42% | Natural Gas BOE/D | 138,876 | 25.44% | Total production BOE/D | 546,000 | 100% |

Appendix 3: Ratio Interpretation Ratio | Indication | Interpretation | Current | The ratio indicates if the company is healthy and efficient with its resources | The higher the ratio, the better | Total Liabilities to Total Assets | The ratio demonstrates how much of assets are financed using debt financing. | The higher the ratio, the riskier the company is. | Return on Assets | The ratio shows the effectiveness of generating income from earnings by management. | The higher the ratio, the better. | Return on Common Equity | The ratio indicates management’s capabilities of turning their money into capital. | The higher the ratio, the better. | Times Interest Earned | The ratio illustrates how well a company can meet its interest expense obligation. | A favorable ratio should be over 1 to meet its total interest expense on its debt. However, a too high ratio shows the company is paying too much into debt, while it could be invested in other projects instead. | Price-Earnings | The ratio estimates the approximate value investors would purchase a stock per dollar of income reported. | The lower the ratio, the better for investments. | Dividend Yield | The ratio indicates how much cash flow investors receive for every dollar invested. | Attractiveness of the ratio (high/low) depends on each individual investor. |

Appendix 4: Husky’s Basic EPS – December 31st, 2011

Appendix 5: Suncor’s Basic EPS – December 31st, 2011

Appendix 6: Husky's Financials

Appendix 7: Suncor's Financials