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Cash Is King in a Downturn

There’s always someone ready to take advantage of someone else’s bad luck. And that’s certainly the case amid the turmoil in Canada’s energy patch.

While many oil and gas producers borrowed heavily to boost growth when times were good, some understood that they would need to preserve capital for when the cycle inevitably turns.

Of course, in this environment, even companies with strong balance sheets and diversified operations are suffering. But they’re not suffering nearly as much as many of their competitors. And that makes all the difference.

The biggest players in the energy sector can afford to take a long-term perspective because they have operations that benefit when energy prices are high, such as exploration and production (E&P), and operations that benefit when energy prices plummet, such as refining.

And diversified operations coupled with prudent financial management mean these firms have the financial strength to scoop up top assets from troubled competitors on the cheap. That’s how the biggest and best firms extend their dominance over the long term.

“Some of the integrated E&P players are actually swimming in cash and need to figure out how to spend a liquidity war chest,” James Jung, an analyst with DBRS, told Bloomberg.

So who’s in the catbird seat on the mergers-and-acquisitions (M&A) front? According to Citigroup, Suncor Energy Inc. (TSX: SU, NYSE SU), which is Canada’s largest oil company and one of our favorite stocks in the sector, could undertake some serious M&A.

And Citi says that Suncor’s strong balance sheet and refining profits put it in one of the best positions to be a major industry consolidator.

In fact, Suncor CEO Steve Williams is looking to put the nearly CAD5 billion in cash on the CAD50 billion firm’s balance sheet to work. “We have too much cash on our balance sheet,” he recently observed. “We’ve been generating more cash than we anticipated when put that $5 billion in the bank.”

However, he also conceded that while Suncor is looking closely at various opportunities, it has “nothing planned” at present.

But as the notion that energy prices could be lower for longer becomes conventional wisdom in corner offices across the sector, this could finally push beleaguered firms to the bargaining table.

Indeed, Williams said that the spread between what Suncor is willing to pay and what distressed firms are willing to accept has narrowed considerably.

Still, he’s willing to be patient for the right deals at the right price, noting that “time is on our side in terms of waiting.”

As for who might be in the crosshairs, Citi says that smaller oil sands producers trading near or below book value might make attractive targets. In particular, analysts cited MEG Energy Corp. (TSX: MEG, OTC: MEGEF) and Canadian Oil Sands Ltd. (TSX: COS, OTC: COSWF), which currently trade at around 0.5 and 0.8 times book value, respectively, as potential takeover candidates.

At the same time, Suncor could opt to return at least some of this cash to shareholders. The firm has certainly done so in the past, with a dividend that’s grown a staggering 23% annually over the past five years.

And it also recently announced plans to buy back as much as CAD500 million worth of shares over the next 12 months. While it could always defer those plans, it’s made good on them in the past, buying nearly CAD900 million worth of shares during the second half of 2014.

Our preference? How about a little of each—M&A, dividends and buybacks—we’re feeling a bit greedy.

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