Thursday, April 28, 2022

Cenovus Reports Q1 2022 Earnings ($CVE)

[Our first article on Cenovus, which is the third largest Canadian oil and natural gas producer and the second largest Canadian-based refiner and upgrader, was Long Reserve Life Oil: Cenovus Energy Inc., followed by Cenovus Reports Q3 2021 Earnings ($CVE), Canadian Oil Sands Earnings (Suncor and Cenovus) - Q4 2021, and Goldman Sachs on Suncor and Cenovus.]

At $19.40 per share (all figures USD), Cenovus has a market capitalization of $38.75 billion and an enterprise value (using their definition of Net Debt of $6.55 billion) of $45 billion.

During Q1, crude oil production from oil sands averaged 595k barrels per day and total upstream production averaged 800k barrels of oil equivalent (BOE) per day. Downstream (refining) crude oil throughput was 500k barrels per day.

This is a nice quarter to use to judge the current earnings power of the business because crude oil averaged $100/bbl during Q1, which is slightly lower than the current level of $105, but much closer than the Q4 2021 average price.

Net earnings (after tax) for the quarter were $1.27 billion. So we are trading for less than 8x annualized net income. One thing that we need to account for, though, is that the company lost $1 billion on "risk management" (crude oil hedges) in Q1, but they have said that they are going to close the hedges: 

"Previously, Cenovus's price alignment and volatility management strategy included the use of crude oil sales price risk management activities related to WTI. Although certain of Cenovus’s crude oil sales prices risk management contracts remain outstanding as of March 31, 2022, these contracts will be closed by June 30, 2022."

If you add back that enormous hedging loss, there would have been about $750 million higher net income for the quarter after tax, to total about $2 billion. That's a 20% earnings yield.

Pretax earnings for the quarter were $1.7 billion, and depreciation and depletion exceeded capital expenditure by $220 million, which gives free cash flow of $1.9 billion. During the quarter, the company spent $400 million repaying debt, $360 million on share repurchases, and $54 million on share repurchases. (Cash on the balance sheet also increased by $410 million.)

If you add back the $1 billion of hedging losses (pre-tax) gives you an adjusted free cash flow of $2.9 billion. That is a 25% FCF/EV yield.

The company announced its capital return strategy going forward:

"The company’s Board of Directors has approved tripling the base dividend starting with the second quarter of 2022, as well as a plan for additional increases to shareholder returns. Beyond the base dividend increase, Cenovus will target to return 50% of quarterly excess free funds flow to shareholders when reported net debt is less than $9 billion. The company will do this through share buybacks and/or variable dividends while also continuing to pay down the balance sheet. Cenovus has adopted an ultimate net debt target of $4 billion. When reported net debt is at the $4 billion floor, Cenovus will target to return 100% of that quarter's excess free funds flow to shareholders through share buybacks and/or variable dividends."

The net debt floor of $3.1 billion (USD) is getting closer. If oil prices stay steady, we could be there in the third quarter of this year. 

Management said that share buybacks will be the preferred mechanism for capital returns, and will continue to be executed opportunistically, driven by return thresholds. Where the value of share buybacks in a quarter is greater than the targeted value of returns, no variable dividend will be paid for that quarter.

The bitumen (oil sands) reserves of Cenovus, alone, were 7.4 billion barrels at the end of 2021 (proved and probable reserves). The enterprise value is $6/bbl and that ignores an additional 0.9 billion barrels of oil equivalent of other reserves, plus the refining assets.

During the first quarter, Cenovus spent between $15 and $20 per barrel on operating, transportation, and blending costs at its two biggest oil sands projects. They spend more per barrel on royalties at these sites ($20-$25 barrel) than they do on operating costs.

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