2023-04-05 07:00:00 ET
Summary
- Cenovus Energy Inc. management has tremendously increased the gross income, net income, cash flow, and profitability of the company in general.
- Industry insiders appear to think the industry is cheap. That is an informed buy signal.
- The time to sell is similar to what we saw with EV car companies going public.
- There are enough operational improvement opportunities for Cenovus Energy Inc. to keep earnings and cash flow growing at a rate higher than production increases.
- A significant dividend increase still appears to be on track in the near future for Cenovus Energy Inc.
(Note: Cenovus Energy is a Canadian company listed on major stock exchanges including the NYSE and Toronto that reports in Canadian Dollars.)
Since I began following Cenovus Energy Inc. ( CVE ) when the deal to acquire the ConocoPhillips ( COP ) partnership interest was announced, this company has made tremendous progress in growing free cash flow far in excess of the stock price advance and any stock dilution. Management still has a lot more possibilities to advance free cash flow better. In addition, it still appears that industry stock prices are historically cheap according to a lot of insiders of the companies in the industry that I follow. So, there is likely an additional possibility of margin expansion.
It is well known, for example, that insiders like those at Headwater Exploration ( OTCPK:CDDRF ) got back into the industry after selling Raging River to Baytex ( BTE ) to take advantage of bargain purchase prices. That management will likely sell again when oil and gas stock prices are back in favor. Similarly, Earthstone Energy ( ESTE ), Diamondback ( FANG ), and Crescent Energy ( CRGY ) all appear to believe that it is cheaper to acquire production than to grow production even though these management do from time-to-time budget some production growth.
As long as I continue to see insiders very active in first forming and then growing companies, it would not appear to be the right time to sell. Cenovus Energy has likewise been on a shopping spree for the past few years. That has turned this company into a cash flow juggernaut. Meanwhile management is likely to continue to optimize operations for years to come. Companies of this size often have multi-year projects to improve operations just due to the sheer size.
The one thing that has changed over the last decade or so is that highly leveraged growth companies appear to be no longer in favor. Nor is drilling for large reserves a market darling either. The focus on strong balance sheets and cash flow has changed the "grow the company and sell it for a profit" game considerably. That has led to the demise of some past successful strategies. Halcon Resources for example reorganized twice after that original management had a number of successes with building and selling leveraged companies.
Cenovus Energy At The Start Of The Journey
Shown below in a previous article is where the journey began:
Cenovus Energy Cash Flow Before ConocoPhillips Partnership Acquisition (Cenovus Energy Management Discussion And Analysis For Fiscal Year 2016)
Clearly the company began the journey as an asset story because the cash flow at the time did not come close to supporting the stock price. An investor reviewing the financial statements could clearly realize that the downstream was in a partnership as well as the thermal operations. There was very little that the company could do without consulting partners. Since then, this company has unwound a lot of partnerships that were not operating well while hopefully retaining the partnerships that make sense.
But since the trend is to unwind partnerships, there may be more of these announcements in the future.
Now the latest cash flow is shown below:
(Note: Canadian Dollars Unless Otherwise Specified)
Cenovus Energy Fourth Quarter 2022 Key Results (Cenovus Energy Fiscal Year 2022 Management Discussion And Analysis)
Reporting has changed quite a bit (that includes how things are classified). Overall, though, results have increased far beyond any stock price appreciation during the same period. The lack of stock price action has resulted in an incredible compression of value ratios like Enterprise Value-to-Cash Flow and Price-Earnings Ratio.
Now the future benefits of the current situation vary widely depending on who gets asked. But most agree that the industry is dirt cheap compared to the industry history. So, it would appear that the cyclical recovery still has years to run.
The biggest difference is that the company has an enhanced downstream presence from the acquisition of Husky. Management further closed on the acquisition of the Toledo refinery for the 50% that it did not own. That sharply lowers the amount of thermal product that needs to be sold on the market. Management is still likely working on this because there are contracts for product and because plants need to be able to handle the thermal product.
But management has been announcing a steady stream of debottlenecking and other related projects to continue to improve overall corporate performance. Those types of announcements are likely to continue for some time to come just from the sheer amount of growth. But that means that production will not have to grow for earnings and cash flow to increase as there appears to be plenty of work to do.
In addition to operations improvement, management has been making small acquisitions and selling non-core assets to further improve future performance. That again, will likely continue into the future. That means there will likely be growth in the future. But the growth pace is likely to slow now that the company is far larger.
Probably a reasonable expectation for long-term earnings and cash flow growth would be single digits to maybe an occasional 10% jump. That combined with management's intention to materially increase the dividend should provide a long-term combined return in the teens for the foreseeable future.
Conventional Opportunities
There is probably a very profitable opportunity with the acquired conventional assets that management has not spent a lot of time on due to all the opportunities to improve the newly combined company operations. That may be about to change.
(Note: Canadian Dollars Unless Otherwise Specified.)
Cenovus Energy Map Of Conventional Acreage Leaseholdings (Cenovus Energy Fourth Quarter 2022, Earnings Slide Presentation)
Management acquired this acreage as part of the ConocoPhillips partnership share acquisition. Since then, this production has been primarily natural gas. Management did have a Clearwater interest that they sold to Headwater Exploration ( OTCPK:CDDRF ) and then periodically sold the stock received in the transaction. The map indicates that there might be some remaining interest.
What seems to be a logical use of this acreage would be an exploration program designed to find condensate that the company mixes with the thermal oil so it flows through pipes to refineries. A discovery of that nature could save the company material dollars down the road.
It does seem like Cenovus Energy Inc. management is heading in that direction with this acreage. But it will take some time for a project like that to become a material size that would benefit the company materially.
There are lots of other possibilities for profitable opportunities on this acreage. But conventional and unconventional are not management emphasis areas at the current time. That is unlikely to change unless there is a darn good lower risk opportunity that can be taken advantage of.
Key Ideas For The Future
Ever since this new Cenovus Energy Inc. management took over, the company has rationalized its balance sheet and increased profitability tremendously. This management is likely to continue to grow the company at a slower pace in the future.
In the meantime, there is plenty to do to increase Cenovus Energy Inc. operational profitability. That is likely to lead to cash flow and earnings growth in excess of any budgeted production growth in the future.
The additional opportunity would be the expansion of industry valuations as the cyclical recovery proceeds. The time to sell is when a lot of insiders start selling the company or when investors see a lot of companies going public (similar to what recently happened with EV car makers). Until that time, there is probably a lot of room for value and dividend increases for Cenovus Energy Inc.
For further details see:
Cenovus: Growth Likely To Continue For Years To Come