2023-10-05 19:04:18 ET
Summary
- Cenovus Energy's dividend yield has fallen since 2014 and is now nearing a 2% yield.
- The company's thermal business generates substantial cash flow, providing protection for cash flow even in scenarios where losses are incurred.
- Cenovus has a strong asset base with long reserve lives, but its valuation and lack of exposure to the LNG market pose risks.
Cenovus Energy Inc ( CVE ) hasn't been that consistent with the dividend yield for investors. It has fallen quite a lot since the highs of $0.25 per share in late 2014. It is gaining quite quickly over the last couple of quarters though and is nearing a 2% yield right now. The valuation has risen quite quickly over the last few months, and I think there is a significant chance that the valuation compressed to reflect the perhaps softer outlook for commodity prices if there are further production rates of both oil and gas. Buybacks seem to continue for the company, so there is some value at least, just not as much to make CVE a reasonable buy yet in my opinion, resulting in a hold for now. In order to say that CVE is fairly valued it would have to drop to similar valuations as the sector, meaning a drop of around 15 - 20% from here, or a share price of $16 - $17 in my opinion.
Business Performance
CVE and its subsidiary companies are actively involved in the exploration, production, refining, transportation, and marketing of crude oil and natural gas, both within Canada and internationally. The company's operations are categorized into several segments, namely Oil Sands, Conventional, Offshore, Canadian Manufacturing, and U.S. Manufacturing. Within the Oil Sands segment, CVE is engaged in the development and production of bitumen and heavy oil, primarily in the northern regions of Alberta and Saskatchewan. The company's notable assets in this segment include the Foster Creek, Christina Lake, and Sunrise projects.
Capital Allocations (Investor Presentation)
CVE enjoys a noteworthy cash flow advantage compared to many of its competitors, primarily stemming from its thermal business. The reason is that the segment and expansion of it often necessitate a significant amount of capital upfront, and afterward the depreciation of the assets is in a way protecting against cash flows. We see this by CVE having positive FCF for nearly a decade, all the whilst the net income has had some years of negative results. Compared to Imperial Oil Limited ( IMO ) which had negative FCF in 2020, CBE outperformed here as they have remained cash flow positive since 2016. In this sector, significant upfront cash investments are typically required before production commences. Consequently, there exists a depreciation component that provides a level of protection for cash flow—a feature less common in the unconventional energy sector.
This unique characteristic means that thermal companies often generate substantial cash flow, even in scenarios where they might incur losses in other aspects of their operations. This can be a key cause for the higher p/fcf that CVE is receiving right now, supplying an 18% premium to peers and the sector. Basing an investment on that would likely result in a hold, as you wouldn't be getting a good and appealing enough price to justify a buy.
Asset Base (Ycharts)
Over the last decade, the asset base has significantly increased to over $40 billion. This has resulted in stronger FCF for the company and has ultimately ensured that CVE can grow the dividend organically thanks to the amount of cash it generates. The company is committed to its base dividend for investors, however the net debts may be. When on the lower end though at around $4 billion, the management has made it clear they aim to return 100% of the earnings to shareholders. The net debts are at $6.9 billion right now, so it lands in the middle of the capital allocations strategy.
Market Overview (Investor Presentation)
CVE boasts top-tier assets that come with impressively long reserve lives, setting it apart in the industry. While many shale companies are gradually depleting their Tier 1 drilling assets, CVE stands strong with nearly 9 billion barrels of oil equivalent in proven reserves. To put it into perspective, this reserve base equates to roughly 31 years of resource sustainability, and this calculation doesn't even account for the potential of consistently increasing discoveries that could further extend this timeline, as noted in the investor presentation. With this sort of asset base, I think that CVE will continue to do very well and capitalize on appreciating commodity prices given the fundamental demand for both natural gas and especially Oil Market Report - August 2023 - Analysis - IEA .
p/e Range (Ycharts)
Valuation-wise, CVE is somewhat below the average it has had the last 5 years. With a median p/e of 14 right now it still has a decent premium to other peers and companies in the broader energy sector. Given that most companies in the sector trade around 10x earnings, I find that CVE offers little immediate upside here. The dividend yield isn't that high and the buybacks aren't substantial enough either. Justifying a buy here seems difficult. What I think may carry the most weight though in terms of the valuation is the p/fcf right now. Given that the earnings can be negative for the business, but the FCF has remained positive throughout the years, I would be getting my fair value from here. The energy sector trades at an average p/fcf of 4.79 right now on a FWD basis. I find this to be the fair value, and that leaves a nearly 18% drop in the share price for CVE before I think it's appealing. The reason I base it on the sector is that getting a similar price or even a discount leaves a more immediate upside. In the case of a broader market correction, I think that CVE may have more room to fall because of this premium being applied. It's a personal preference, but it does mean my fair price range is between $16 - $17 for the company right now.
Financial Overview (Investor Presentation)
As we have discussed, the dividend of the company seems sustainable right now, given that it's far lower than some years ago. At WTI prices of $45, the base dividend is sustainable, and as we know, we are more than 2x higher than that right now, approaching $100 even. Investors should be keeping an eye on the coming reports from the company and see if there is an acceleration of the buybacks for the shares. Given that oil prices have climbed quickly, there is a chance that CVE may be able to capitalize on this and return larger sums to shareholders. But time will tell if that is true, and maintaining a neutral rating now is the best risk-adverse approach.
Financials
CVE has in the last few years prioritized more and more to maintaining a high cash position, which I find very positive. It now sits at $1.6 billion, up from $297 million in 2020. This improved state will enable CVE to make more strategic expansions and acquisitions if they see fit. The total assets have also seen a lot of growth, more than doubling since 2016.
Debts have not seen such a drastic shift over the last few years, which is positive. They sit just above $6 billion and with CVE generating quite a strong EBITDA still, I don't see the debt levels the company has built up as something that would seriously hurt their expansion plans. In quite recent news, it was announced that CVE is increasing its tender offer for certain outstanding series of notes. The company announced it had increased the previous Pool 2 maximum from $250 million to $500 million instead.
Risk/Reward
Cenovus currently lacks exposure to the rapidly expanding global liquefied natural gas ((LNG)) market, which is known for its robust profitability. This absence of involvement in the thriving LNG sector might lead to a comparatively lower valuation of the company and consequently, reduced potential returns for its investors. However, it's worth noting that CVE stock price has experienced a notable uptick in recent months. This rapid ascent could potentially signify an impending correction in the market, introducing the possibility of downside risk for investors who have seen substantial gains during this period.
Debt Levels (Ycharts)
CVE has dedicated substantial efforts to reduce its debt burden over the past few years, a strategy that investors have been closely monitoring. The expectation is for the company to sustain this trend of debt reduction. However, should CVE encounter challenges in meeting these expectations, it could introduce additional risk to the investment landscape. In particular, a high leverage ratio in a period of elevated interest rates can be a cause for concern, potentially impacting the company's financial stability and valuation. Right now, the net debt/EBITDA of 0.98. This is quite low and is under the expectations as well that CVE manages to continue paying down the debt levels and that EBITDA remains high. In 2020 the EBITDA was under $400 million. This was the result of lower commodity prices, which if it happens again could lead to a higher leverage ratio for CVE and in turn a lower valuation to reflect this.
Key Notes
CVE has a significantly lower dividend yield right now than a decade ago, but it seems the market is thinking it will appreciate quickly as well as the buybacks. However, I don't see the immense potential that some others may, and given the premium it trades at it leaves little immediate upside potential. Without trading at a risk-free rate, I won't be viewing CVE as a buy currently, but rather a hold instead.
For further details see:
Cenovus Energy Inc: Not Getting A Lot Of Value Here