CA - MEG Energy: The Buybacks Just Keep Coming

Summary

• MEG continues to put off paying a dividend but is committed to spending 50% of FCF on buybacks.
• MEG has reduced its debt by $3.5 billion since 2016, and the focus remains on getting under $600 million.
• MEG looks set to make a run at $40.

MEG Energy ( MEGEF ) or ( MEG:CA ) is one of my favorite names in the Oil & Gas industry. The company has a very disciplined share buyback program and does not pay a dividend, all while remaining unhedged. I do think it would be challenging and risky to start a dividend program while being unhedged, but I am in full support of their current shareholder return strategy. MEG has done a phenomenal job of generating Free Cash Flow and lowering Net Debt in the process. The company is on track to get under the $1 billion Net Debt mark in 2023. I am bullish on MEG and a proud shareholder.

What's Driving MEG?

What is higher oil prices, creating a surplus in free cash flow, Alex? CORRECT! As MEG remains one of the few brave enough to take the Oil world on totally unhedged, the cash just keeps on flowing. There's no need to do any fancy math to figure out what their average sale price is on a barrel or where they really need WTI pricing to be to get the desired outcomes. It's expected that MEG pulled in over $1.6 million of Free Cash Flow in 2022. With the price of oil averaging just under $100 a barrel in 2022, that's not shocking. Early estimates for 2023 FCF are much lower given the change in the price of oil. Keep in mind it's always better for MEG to aim lower, and finish higher. The important number is $45 per barrel. The capital program can be funded with $45 oil. Everything over that is gravy.

Looking above, we can see the breakdown as to where the FCF could potentially land depending on which way oil decides to go. I am still very bullish on the sector as a whole and therefore see no reason for any concern here. Even at $60 oil, we are still going to see buybacks which is pretty impressive.

One of the issues that MEG faces is the differential between WCS and WTI. From 2019-2022 the differential has averaged about $14.15 a barrel. We are currently seeing a $23 gap between the two due to a number of factors. But with respect to MEG, each $1 in differential tightening increases the estimated adjusted funds flow by $45 million . That adds up quickly. MEG and I both seem to agree that we will see a tightening on this spread over the course of 2023 as the supply/demand for heavy crude balances out.

As for current guidance going into 2023, MEG is expecting to see 100,000+ barrels a day of production on $450 million of CapEx. One of the signs to watch for in the industry is a sudden influx of CapEx. We are not seeing that across the industry in 2023 guidances which is encouraging. Companies are continuing to make paying down debt and growing production with maintained CapEx a priority, which is great news for shareholders.

Where's My Cheese!!

Now, why we're all here. When will they pay a dividend?! It's starting to feel like never, but that's not such a bad thing. Many mistake the value that buybacks add to a share price. The instant gratification of a dividend is something many crave, and probably a reason many don't own MEG. Just so everyone's clear as to what a buyback is, it is when the company (MEG in this case) literally buys shares of itself and removes them from the float or outstanding shares. Often companies will do this when they feel they are not being valued properly in the market, which I believe is the big driver for MEG to continue to buy back shares versus offering a dividend. The other piece of the puzzle is that the buyback instantly improves financial ratios/metrics. EPS is one of the metrics that this helps as earnings don't see any change, but the number of shares does. Better earnings usually lead to higher share prices, not to mention, when you take a piece of the pie away, the value of the other pieces increases naturally. I personally have absolutely zero issues with MEG not issuing a dividend at this time.

Looking above, we can see just how the breakdown of funds will play out based on debt. This is a common theme across the space. MEG is currently sitting at roughly $1.4 billion in debt. This is good for a leverage ratio of about 0.7x. In other words, the balance sheet is in a great spot. But if you are looking for that "cheese", you may have to wait till we see $600 million. Looking above we can see a breakdown of the targeted arrival date based on the price of oil. I do think we will see between $80 and $100 most of the year, which points towards an arrival date of early 2024. Looking below, the analysts seem to agree with my thesis. The work that MEG has put in to pay down this debt is incredible. Back in 2016, the company has almost $5 billion in debt and a 23x leverage ratio. Crazy to think about how far they have come.

So what do we do in the meantime? Well, as we head into a period of seasonal strength, we wait patiently knowing that MEG's management will continue to buy back shares and increase shareholder value over the next year. We're all getting our cheese, just not in the form of a dividend.

What Does The Price Say?

Remember when I said companies will buy back shares when they feel their company is undervalued? Well, look below to get an idea as to why MEG is taking the approach that they are. The best part is $47.92 wouldn't even be an all-time high. Do I think this is possible? Yes. Do I think we see this in 2023? I'm not so sure. Based on technical analysis, my current price target on the stock is $40, and $47 isn't far from that, but the time frame is tricky. If we see oil over $100 for an extended point of time, there's no doubt we could get there in my opinion.

Diving into the path to $40, we have to look back to 2014/15 to find the resistance we are looking for, and it's there in a big way. Looking below we can see a weekly chart showing just what I'm looking at. More recently, $25 seems to be a point of contention, and I fully believe MEG will make another run at $25 shortly. The question is, will we break through? Your guess is as good as mine, but what I can tell you is that if and when we do, that will act as support on the way to $40. $25 is only another 10% from current levels, but it is a key level to watch for sure.

The stop here is very tricky. Especially if you aren't in the black, or just in the black. Why? Well, looking below you can see the same chart I posted back in December of 2021 when I mentioned that it's not too late to get in MEG and I had $13.30 and $17.50 both tagged as targets on the road to $25. Well, we can see how both of these levels are now working as support. But very choppy support at that. The big issue is that from current levels, $17.50 is 23% down and $13.30 is 40% down. Both stops are exposing you to way too much risk on a standard position size. There really isn't anywhere else I would feel comfortable placing a stop until we see $25 break.

Does this mean you should steer clear? No, it just means you have to manage your position accordingly. I wish I could offer clearer advice on this one, but it's a bit riskier of a setup at this current time, but is one I really like on a fundamental basis and it is looking as if it will make a push to $25 shortly. It will be volatile, and it's not for the faint of heart, but it's a stock with a lot of potential torque in it beyond $25.

Wrap-Up

The stock speaks for itself. Even though placing a stop is a little tricky right now, it's hard to find a better company in the current environment. As long as you can get passed the mental hurdle that is buybacks versus a dividend, MEG is a stock I think anyone who's bullish on oil should own. I am long MEG and looking forward to $25, and $40 after that. One day at a time. Keep those stops set, and sleep well at night.

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