2023-09-01 13:30:30 ET
Summary
- The Cenovus Energy Inc. acquisitions made now have to be optimized for the overall organization.
- The refineries starting up are switching from needing cash to generating cash (and profits).
- Sunrise will likely lower some very high breakeven costs.
- At least some cash flow will be used to grow the company business and will likely be subtracted from the free cash flow calculation available to shareholders.
- Long-term debt reduction progress will resume. But future acquisitions cannot be ruled out.
(Note: Cenovus is a Canadian company that reports using Canadian dollars unless otherwise noted).
Cenovus Energy Inc. ( CVE ) made a few acquisitions that resulted in a bunch of one-time expenditures. Two refineries also began operations while the acquisition of Sunrise is being optimized. In the future, the refineries will switch from needing cash to generating cash while Sunrise should have a lower breakeven point. This should increase the free cash flow performance at various commodity price points. Management has more projects in the works. But those projects will have more cash to be used. This growth from all the acquisitions should continue for years to come.
Cenovus Energy has a cash flow advantage over many competitors because the thermal business often requires a relatively large cash investment first before production begins. Therefore, there is a depreciation component that protects cash flow to an extent not usually seen in the unconventional business. The result is that thermal companies generally cash flow generously even if they lose money.
Cenovus management appears to have determined that some cash flow will be used to grow the company business. That decision is part of the free cash flow calculation used to determine the cash available to return to shareholders. Investors need to remember that Free Cash Flow is not GAAP or any other accounting standard. Therefore, the calculation of Free Cash Flow can and in fact does vary among companies. This should be expected when there is no formal standard. That means Free Cash Flow is often not comparable until the numbers are reviewed and adjusted for an "apples to apples" comparison.
Cenovus Energy Summary Of Second Quarter 2023, Results (Cenovus Energy Second Quarter 2023, Earnings Press Release)
Obviously, the debt progress came to a grinding halt when the acquisitions were made. But management remains focused enough to resume progress as shown above.
Rising prices of commodities should help that forward progress. But so will the transition of cash-using assets to cash generating assets.
Longer term, the acquired refining assets need to be optimized to maximize the profits of the combined company. That means that the refining and upgrading process will need to handle more thermal oil production in the future while turning that oil into profit maximizing products. Given that the market price relationships can change due to supply and demand imbalances, this demands a flexible manufacturing process.
Cenovus Energy Downstream Production Mix (Cenovus Energy Second Quarter 2023, Earnings Slide Presentation)
The above can be thought of as a starting point. The same can be said for current utilization rates and other key production figures that help to determine overall profitability.
The main goal is to avoid periods of thermal oil pricing weakness that decimated results in the past before there was more refining capacity. Some products like asphalt, could well reflect thermal oil pricing weakness even though they are value added because the primary source of asphalt is a discounted product.
Others, like gasoline, can also be made from light oil and therefore are likely to have a sales price that "holds up better" during times of weak commodity prices (during a cyclical business downturn cycle).
This process will likely take years (rather than happen overnight). That implies a gradually widening corporate margin when compared to the past under similar conditions. Given that commodity prices fluctuate all the time, this is the kind of progress that shareholders find hard to see happening.
The other thing is that the acquisition of more refining capacity over the last few years means that there is a switch in suppliers to the Cenovus thermal production. This can be traumatic for the refining business as well because thermal supplies can vary. Sometimes, the variation is so great that capital expenditures to the refinery are required. Therefore, using Cenovus products at the acquired facilities may take some time in addition to taking the time needed to maximize profits using this supply source.
Other Growth Projects
Long term, there is still a very clear need for more refining capacity.
Cenovus Energy Current Production Supply From Upstream Compared To Downstream Capabilities (Cenovus Energy Second Quarter 2023, Earnings Conference Call Slides)
As can be seen above, there is still a fair amount of production that is exposed to commodity prices because there is no downstream capability for that excess production. Clearly, management can make money on that production selling it at commodity pricing, or they would not produce it in the first place.
But long-term, enhanced profitability will likely happen through the expansion of downstream capabilities. Management has noted some debottlenecking opportunities. But left unsaid is that management is probably opportunistically shopping for a refinery or two that can fit the corporate organization.
While the company has made considerable progress, there is clearly still a lot of potential upside in the optimizing profits process.
Upstream Profit Growth Projects
In addition to the previous discussion, management plans to grow upstream production. While that makes downstream production expansion capabilities a priority as well, it does mean that this management has a full plate of future growth projects "on the table."
An integrated company often means that growth in place often implies growth elsewhere to optimize profits.
Cenovus Energy Thermal Production Growth Plans (Cenovus Energy Second Quarter 2023, Earnings Conference Call Slides)
What this appears to point towards is high single-digit growth rates for the company well into the future. Now that the company is far larger than it was when I first initiated coverage, the initial frantic growth rate will give way to a growth and income strategy for the foreseeable future.
That means total annual returns from growth will likely decline. But the increased safety of an enhanced downstream division will remove some of the corresponding risk to achieve what management likely believes is an acceptable proposition to Mr. Market.
There are other possibilities in the offshore and overseas business. But probably the most attractive idea is for the unconventional business (or conventional depending upon the area) to find condensate that can be used by the company to make the oil produced flow through the pipelines. If this happens and is successful, then it would eliminate a major purchase from outside suppliers.
Management has at times mentioned the need for condensate and wants to explore the acquired acreage for more products than the current natural gas production. But there is no guarantee of success. The speculative upside for shareholders would be company supplied condensate as a major cost reduction.
Summary
Cenovus Energy Inc. management has done very well, as quarterly cash flow is up something like 16 to 32 times (depending upon commodity prices for the quarter) since I began coverage of this company about 5 years ago. Obviously, there is still a lot of work to be done.
There is also a potential foray into the Chemicals business that many diversified giants have.
The very low stock price valuation protects against the threat of downside principal loss over the long term. It should be noted that Mr. Market really has yet to give the company any credit for the larger downstream operation. This company is a strong buy consideration because the upside potential from all those acquisitions far exceeds any downside potential at the current price.
As long as Cenovus Energy Inc. grows, I intend to hold the stock until the story changes materially. However, the volatile trading price does allow for a lot of trading opportunities along the way. So, there are likely to be a lot of ways to make money. With the currently low market valuation, the odds are in your favor.
For further details see:
Cenovus Energy: Cash Drain Ending