Summary
- Cenovus Energy Inc.’s Q4 results fell short of consensus estimates.
- But the results were not as bad as the market's reaction implied.
- Quarterly results are likely to improve going forward.
- Cenovus Energy's selloff has created an attractive buying opportunity for long-term investors.
Cenovus Energy Inc. (CVE) investors woke up this morning to an ugly Q4 earnings report . The company missed analyst expectations for funds from operations ("FFO") per share by 6%, reporting C$1.17 versus expectations of C$1.24. The miss was driven by lower-than-expected oil sands sales volumes, a larger-than-expected cash tax payment, and an unusually weak performance from CVE's U.S. refineries. The news sent CVE shares plunging as much as 9% shortly after the open before they rebounded later in the day to close at $18.46, down 4.9%.
In addition to the funds from operations miss, Q4 capex came in 17% higher than consensus expectations. The market is particularly sensitive to E&P capex increases, as witnessed by the thrashing it delivered to Devon Energy Corporation ( DVN ) shares yesterday, largely in response to its outlook for higher capex. CVE's Q4 higher capex also reduced free cash flow available for dividends and share repurchases. Consequently, its Q4 free cash flow fell 23% below expectations. The lower free cash flow limited quarterly buybacks to C$387 million, versus C$2.14 billion over the previous nine months.
Operational results were also weak. While Q4 production results were in line, at 807,000 boe/d versus expectations of 810,000 boe/d, oil sands sales volumes disappointed by tracking 18,000 boe/d lower than production volumes. For the downstream segment, refinery throughput was broadly in line with expectations.
Capital allocation was another sore spot. As lower commodity prices, operational disruptions, and a severely discounted WCS acted as a drag on cash flow, CVE failed to meet management's C$4 billion net debt target by year-end 2022. Moreover, a C$1.2 billion cash tax payment and a $300 million payment toward the purchase of 50% of the Toledo refinery will increase the company's Q1 net debt balance. As a result, management now expects its C$4 billion net debt target to be hit at the end of Q3, two-to-three quarters later than what it had guided and what the market had expected before CVE announced Q4 results. The C$4 billion net debt target represents the shift from paying out 50% of excess free cash flow to shareholders to 100% of excess free cash flow. No doubt management disappointed many shareholders by pushing back the arrival of higher dividend and/or share repurchases.
And to top it all off, CVE announced an unexpected management transition that will see its highly-regarded CEO, Alex Pourbaix, transition to an executive chairman role. Pourbaix is turning over the CEO role to Jonathan McKenzie, CVE's Chief Operating Officer.
The lone bright spot in Q4 results was CVE's Canadian refinery financial results, which benefitted from the blowout in WCS differentials.
Q4 Results Were Not As Bad As The Ongoing Selloff Implies
As bad as Q4 headline results were, they were caused by one-time items unlikely to repeat. In no way do they signal a problem with CVE's underlying business. In fact, we believe CVE's business results have already begun to inflect in a positive direction.
CVE's Q4 revenues declined due to lower commodity prices, which we believe will be short-term in nature, and a blowout of WCS differentials that has already corrected toward historically normal levels. Furthermore, the decline in fourth-quarter funds from operations per share was exacerbated by a large working capital draw attributable to a decrease in accounts receivable and an increase in taxes payable. These are lumpy cash flow items that happened to move against the company in the fourth quarter. Their quarterly fluctuations have no bearing on CVE's intrinsic value.
Consider further that the 18,000 bpd difference between Q4 production volumes and sales volumes was attributable to management's decision to throttle back sales volumes as WCS prices plunged relative to WTI. Management opted to forego sales into a distressed market in order to wait for more favorable pricing conditions. While the move hurt Q4 financial results, it's the kind of discipline we like to see as long-term shareholders. Such long-term-oriented behavior is rare among E&Ps, and it demonstrates CVE's superior operating platform and value-conscious management.
The U.S. refinery segment was partly to blame for the Q4 financial underperformance. However, the refinery operating and financial disappointments were attributable to events outside of management's control. For example, U.S. refinery throughput took a hit from the outage on TC Energy's ( TRP ) Keystone Pipeline in December, as these refineries receive a portion of their crude feedstock through Keystone. The upstream side saw less of an impact, as CVE compensated for the loss of Keystone by ramping up crude-by-rail shipments through its Bruderheim rail terminal.
CVE's downstream segment was negatively impacted by severe weather, unplanned operational events, and the Keystone outage-all of which are unlikely to repeat. Management reported that by mid-January, all but one of CVE's refineries were running at normal rates. The straggler, the Wood River refinery, is expected to be operating at normal rates by Q2.
CVE is set to enter the second quarter with all its refineries running at or near normal throughput rates. Later this month, it will acquire the 50% stake in the Toledo refinery it doesn't already own. The refinery had been shut down after it was damaged in a fire in September, and management expects it to be running at full rates in Q2. In addition, CVE's Superior refinery, which was idled in 2018, has been rebuilt and will begin ramping throughput over the next few weeks.
CVE will benefit significantly from increased refinery throughput, particularly since refining margins are likely to remain elevated as long as refined product demand remains robust. For perspective, in 2022, CVE's Canadian refinery throughput averaged 92,900 bpd, and its U.S. throughput averaged 400,800 bpd. For 2023, management is guiding to Canadian refinery throughput of 105,000 bpd and U.S. refinery throughput of 530,000 bpd.
Refineries have high fixed costs, so declining throughput squeezes per-barrel margins. Conversely, rising throughput boosts margins and cash flow. The Toledo and Superior refineries have been under construction. They have been generating no revenue, yet their operating costs run more than C$40 million per month. As their throughput increases over the coming months, their contribution to CVE's financial results will flip from a drag to a tailwind.
Lastly, CVE's capital allocation disappointment was also better than it looked at first glance. During today's conference call , management reassured shareholders that it was laser-focused on achieving its C$4 billion net debt target. Its revised Q3 target date is based on current oil prices remaining flat. We expect oil prices to increase beginning in Q2, and higher oil prices make it likely that CVE will achieve its debt target earlier than management's guidance. We believe a mid-year target is more probable, which would represent a delay of one-to-two quarters. While inconvenient, this shouldn't be a major concern for long-term shareholders.
Conclusion
We noticed that some disgruntled CVE shareholders compared the company's Q4 miss to that of Devon Energy. This is an apples-to-bananas comparison. DVN missed on Q4 production and guided to higher capex in 2023. Its results suggest it may be struggling to sustain its performance on the shale treadmill. We view the reaction to DVN's results as a rational response to an inferior business model. Our first thought when we saw DVN's results is that it should never have disposed of its oil sands properties in 2019.
By contrast, Cenovus Energy Inc.'s Q4 disappointment does not imply anything negative about its long-term economics. The severe market reaction, therefore, makes little sense. We expect better quarterly results going forward and view the current Cenovus Energy Inc. weakness as an attractive buying opportunity for long-term investors.
For further details see:
Cenovus Energy: Market's Overreaction To Weak Q4 Serves Up A Buying Opportunity