2023-06-06 06:01:37 ET
Summary
- Cenovus Energy (CVE) has lost some investor confidence through recent guidance misses on debt reduction and shareholder rewards.
- Continued focus on debt reduction and aggressive shareholder return schemes could make it a longer-term Buy when committing to initiatives.
- In the face of strong growth and production capacity increases, there remains potential to capitalize on favorable supply-demand economics following from OPEC announcements.
- Investor patience could pay off greatly towards the end of the year, as targets are prioritized CVE may grow into a force that cannot be ignored.
Investment Thesis
Cenovus Energy (NYSE: CVE ) presents great future potential as it focuses efforts towards debt reduction and aggressive shareholder return schemes, however we believe it currently presents a Hold opportunity as we wait for confirmation of guidance delivery. Growth across the last few years has rocketed, rendering CVE capable of greater production capacities and an opening an opportunity to capitalize on OPEC volatility, rendering CVE a potential long term Buy in the case that debt shrinks at expected rates.
Unsteady Progress
CVE are a large integrated energy company operating out of Calgary in Canada with core operations extending throughout Canada, the USA and the Asia-Pacific region. As an integrated energy company, CVE is mainly exposed to crude oil and natural gas resources, with refining operations generating further value-added products.
Poor Q1 2023 results relative to expectations resulted in weak price action following the announcement of lower production rates and planned debt management experiencing delays. This is primarily a concerning indication of continued underwhelming performance towards meeting targets. Continuation of missed guidance surrounding debt reduction and shareholder incentives will only serve to damage credibility and hurt investor confidence.
Q1 2023 also saw the Stanley Druckenmiller’s Duquesne exit their long position in CVE, citing concerns surrounding continued bankruptcies and broader dollar weakness. This also follows a downgrade from Scotiabank back in April in the face of temporary weakness in refinery margins and lower downstream cashflows throughout the US market.
Recent wildfires throughout Alberta and the wider West Canadian region have no doubt disrupted operations within Canada and shaken margins unexpectedly, as it was reported that CVE suffered a cut of around 85 thousand barrels of oil equivalent per day through processing shutdowns. This represents one of the more significant curtailments on any energy company within the region, however CVE have stated their annual guidance range is still under maintenance. This situation seems to be improving as alternative companies are beginning to restore operations .
Direction Towards Shareholder Focus
Following Q1 2023 earnings, CVE announced a quarterly dividend with a 33% growth rate to $0.14 per share, demonstrating a focus from management towards shareholder incentives in the event of increased cashflows. The current dividend payout ratio is just over 20% , representing room for growth and demonstrating sustainability in planned cashflow allocation initiatives. As managements debt reduction targets are set to be reached by the end of 2023 , this will further unlock capital to be distributed to shareholders directly via raised dividends. Dividend growth may also occur simultaneously with share buyback schemes.
Despite impressive growth, CVE doesn’t offer the most consistent of dividend pay-outs, as demonstrated by the snapshot of Seeking Alpha’s dividend grades below. Income investors may desire alternative investments when considering reliability.
The case for CVE share price rises is potentially improved when considering the likelihood of oil price growth towards triple digits in the face of recent OPEC+ announcements concerning the desire to cut supply. This, when coupled with consistent and gradually rising demand creates an interesting dynamic for CVE to capitalize. The takeaway from the combination of the factors discussed mean that CVE looks to be in a promising position to leverage this situation in the second half of this year, which is when we expect management to ramp up planned shareholder capital distribution.
Earlier in February, CVE completed the acquisition of the remaining 50% share in BP’s Husky Toledo refinery in Ohio, diversifying its refining environment and increasing downstream capacities. CVE now fully owns this refinery, following the merge with Husky back in 2021. This gives way to an updated annual production target of over 790 thousand barrels per day.
There are several strategic benefits revolving around this acquisition, however many investors were left feeling deflated in the face of little communication surrounding the tax liabilities involved. Such large acquisition costs serve only to delay promised capital distribution to shareholders.
Increasing Efficiency
Managements focus on turning the direction towards shareholder incentives through debt reduction has improved the financial position of CVE significantly, even if it has taken longer than originally anticipated. Debt to equity has fallen by 44% over the last two years to a current value of 0.40.
In the last 2 years, return on equity has grown from 2% to 21%, demonstrating an upturn in efficiency with capital in the aftermath of the pandemic, potentially helping to build a greater moat around specific business areas and develop a sustainable edge for the years to come.
As a result of this efficiency upturn, there has been a long-term general increase in free cashflow available to CVE to fund debt reduction initiatives, whereby free cashflow has risen by an average of 82% annually for the last 3 years from around $2.1 billion in Q4 2019 to $7.7 billion in Q4 2022 . The debt reduction initiative would not have been possible without this remarkable turnaround and could reinforce CVE for the remainder of the decade. It must be said that free cashflow reduced by 26% in Q1 2023 to $5.7 billion, this is partly as a result of costs associated with the acquisition mentioned earlier; possibly hindering planned progress.
In the face of such an impressive upturn in profitability and growth across the last few years, we would agree with Seeking Alpha’s relevant factor grades depicted below. The Quant rating recently changed from Buy to Hold towards the end of April as a result of the growing concerns mentioned earlier.
Technical Tightrope
The price of CVE has currently dipped below the 200-Day EMA following a struggle to break above back at the beginning of April, as shown below . The price has been more or less consistently around and above this long-term trend indicator since November 2020.
This means that investors would likely be keen to see a short-term return to the $17.50 levels as a sign of trend continuation rather than an early indicator of a possible longer-term trend reversal.
Conclusion
In conclusion, investors have been left with a slightly bitter taste following on from recent guidance misses and lackluster clarity regarding acquisitions. This could generate reputational issues whereby credibility is questioned. As well as this, margins will no doubt be hurt by recent wildfires which have forced production cuts and margin hits.
Despite this, CVE management continues to throw focus on the direction towards releasing capital allocation to shareholders once debt reduction targets have been met. Dividend hikes and share buybacks loom over the horizon towards the back end of this year which will please shareholders. Coupling this with OPEC volatility and the potential to capitalize on oil strength, CVE seems set to rise back towards the $20 level and perhaps beyond.
Greater production capacities on the back of strategic acquisitions highlight the quality of long-term oriented management decisions in recent years which has bred high efficiency metrics and boosted cashflow to begin an effort towards debt reduction.
As a result of a combination of all factors, we have concluded that CVE deserves a solid Hold rating until it becomes clearer that debt targets are being prioritized over new acquisitions and strategies regarding capital allocation are announced, at which point shareholders will be convinced that previous communications are being honored.
That said, followers of CVE whom are not concerned over recent developments may find a great company that presents a well-placed Buy rating. Either way, CVE has been growing at a pace that is difficult to ignore across the past couple of years following the pandemic, resulting in a well-positioned integrated energy play that rests on continually strengthening financial ground; patience is that approach we would take here.
For further details see:
Cenovus Energy: Investor Patience Could Be Rewarded Toward Year End