Thursday, November 3, 2022

Oil Producer Earnings - Q3 2022

Our four oil producers - Suncor, Cenovus, Canadian Natural Resources, and Marathon Oil - have all reported results for the third quarter. (All figures for the Canadian companies are in USD with an 0.73 exchange rate.)

Suncor's market capitalization is $47 billion (at a $35 share price) and the enterprise value is $58 billion. They reported earnings [pdf] of negative $445 million, however there was a non-cash writeoff of $2.5 billion which was necessitated by their buyout of a minority joint venture partner as a cheap price. Their adjusted earnings were $1.87 billion for the quarter, which means that shares are trading for 6 times annualized (Q3) earnings. Adjusted funds from operations for the quarter were $3.3 billion, which gives an annualized (Q3) AFFO/EV yield of 23%

Their proved and probable reserves were 5.8 billion barrels as of the end of 2021, so that's an enterprise value of $10 per barrel. The PV-10 of their proved and probable reserves was $50 billion at year-end 2021, which was calculated based on the $66.56 average WTI price last year. That means the present value of the reserves at a much lower oil price than current WTI covers almost all of the current enterprise value. Keep in mind in addition to the value of the upstream reserves, Suncor also has its refining and marketing operations, which generated $1.8 billion of AFFO during the third quarter.

So far this year, Suncor has returned $4.3 billion to shareholders via dividends and repurchases, which is a 12% annualized shareholder yield on the current market capitalization. Net debt has also been reduced by $1.1 billion. This has all been made possible by $8.6 billion of operating cash flow (less $2.7 billion of capex) year-to-date. (Shares outstanding have decreased by 6% ytd and 7.5% over the past twelve months.) Some conference call comments on capital allocation going forward:

We successfully completed an upsized bond repurchase tender that resulted in buying back our debt below face value, and lowering our structural breakeven by nearly $1 per barrel on a WTI basis. These actions keep us on track with our capital allocation framework and move us toward our goal of reducing our net debt and depending on commodity pricing, increasing capital allocation to share buybacks to 75% by the end of Q1 2023. I would now like to move to our progress on our efforts to optimize our asset portfolio towards our core integrated business. As you know, we've initiated a robust process to divest from non-core assets to increase and focus in our portfolio. Recently, I announced the sale of our wind assets for $730 million. And also during the quarter, we closed the sale of our Norway E&P assets. Meanwhile, the process to sell our UK E&P assets continues, and I expect that process to conclude in the coming months. A portion of the proceeds of these non-core asset sales is being used to increase our operated ownership interest in the Fort Hills asset by approximately 21%. This additional interest in Fort Hills demonstrates our confidence in the long-term value of the asset, which is backed up by a detailed assessment by our new and highly experienced mining leadership.

Fort Hills has a cash operating cost of around $19 per barrel. After buying out the 21% working interest stake in that project from Teck Resources, Suncor management did a cash flow projection using a long term oil price forecast of $60 and found that an impairment was justified on that basis.

Cenovus's market capitalization is $40 billion (at a $21 share price) and the enterprise value is $54 billion. They reported earnings [pdf] of $1.2 billion, which means that shares are trading for 8 times annualized (Q3) earnings. Adjusted funds from operations for the quarter were $2.2 billion, which gives an annualized (Q3) AFFO/EV yield of 19%.

The bitumen (oil sands) reserves of Cenovus, alone, were 7.4 billion barrels at the end of 2021 (proved and probable reserves). Producing at a rate of around 620k barrels per day is a quarter of a billion barrels per year, giving you a 30 year reserve life. The enterprise value is about $6 per barrel and that ignores an additional 0.9 billion barrels of oil equivalent of other reserves, plus the refining assets (which have already earned over a billion dollars year to date). 

So far this year, Cenovus has returned $1.8 billion to shareholders via dividends and repurchases, which is a 6% annualized shareholder yield on the current market capitalization. Net debt has been reduced by $3.3 billion, which is much more aggressive debt repayment as a percentage of market cap or enterprise value than Suncor, and explains the lower shareholder yield for Cenovus. This has all been made possible by $6.1 billion of operating cash flow (less $1.75 billion of capex) year-to-date. Some conference call comments on capital allocation going forward:

In accordance with our shareholder returns framework, we've allocated half of Q3 excess free funds flow to shareholder returns. This is over and above our base dividend. We also continued our opportunistic and disciplined approach to share buybacks through the quarter. This resulted in a return of about $660 million to shareholders through the NCIB program. In addition, the Board of Directors has approved a variable dividend of about $220 million, or roughly $0.14 per common share with this variable component, fulfilling our commitment for 50% of excess free funds flow going back to shareholders. The current NCIB program will expire in early November. As we announced earlier, this morning, our Board has approved the application for another NCIB program. It will provide capacity to repurchase approximately 136 million additional common shares over the next year. We also completed a tender transaction in the quarter, repurchasing about $2.8 billion of debt, bringing our total of repurchase notes this year to $4.3 billion. This exercise mitigated refinancing risk for the company until 2027. It also reduced our weighted average coupon rate, and will save about $200 million in annual interest expense going forward. Our net debt reduction was accelerated this quarter by a working capital release, and now sits at about $5.3 billion. And to put things in perspective, we started this year with $9.6 billion in net debt. So that is a reduction of $4.3 billion of net debt in just three quarters.

Management also commented that they view share buybacks as most attractive below $15 and would prefer dividends above a $22 share price - but that is assuming a $60 oil price. That says something about the valuation at the current $21 share price.

Canadian Natural Resource's current market capitalization (at a $60 share price) is $67 billion, and the enterprise value is $76 billion. They reported net earnings of $2.0 billion for the quarter, which means that shares are trading for 8 times annualized earnings. The adjusted funds from operations of $3.8 billion for the quarter is an annualized (Q3) AFFO/EV yield of 20%.

Their proved reserves of liquids at the end of the 2021, net of royalties, were 9 billion barrels, calculated based on a $66 price for WTI. We are paying around $8 per barrel of proved reserves of liquids at the current share and that does not count the 12 trillion cf of natural gas reserves. The PV-10 of proved reserves at the end of 2021, again assuming a $66 oil price and a $3.70 Henry hub natural gas price, was $65 billion. The enterprise value is now 1.17x the present value of the proved reserves at a much lower oil price.

Amazing: "year- to-date, up to and including November 2, 2022, [Canadian Natural Resources] has returned a total of approximately $10.0 billion to shareholders comprised of approximately $4.9 billion in dividends and approximately $5.1 billion in share repurchases." Those figures in CAD; the USD is $7.3 billion of shareholder returns, which is a 13% annualized shareholder yield on the current market capitalization. They have also reduced their net liabilities by $1.5 billion so far this year. This has all been made possible by $10.8 billion of operating cash flow (less $2.8 billion of capex) year-to-date.

Marathon Oil's current market capitalization (at a $31 share price) is $20 billion and their enterprise value is $24 billion.They reported net earnings of $817 billion for the quarter, which means that shares are trading for 6 times annualized earnings. Free cash flow was $1.1 billion for the quarter which is an annualized (Q3) FCF/EV yield of 19%.

So far this year-to-date, Marathon has spent $2.5 billion on share repurchases and $162 million on dividends, for a total of $2.7 billion returned to shareholders, which is an 18% annualized shareholder yield on the current market capitalization. 

We noted after Q2 that their sales volumes had been down 1% year-over-year from 348k boe/d to 343k. However, in the third quarter, their production was 353k boe/d, which was up 3% year-over-year. Capital expenditures were $413 million in Q3 2022 versus $308 million the prior year. Some conference call comments on capital allocation:

As we have consistently highlighted, we believe our return of capital framework is differentiated in our peer space, uniquely calibrated to operating cash flow, not free cash flow, prioritizing our shareholders’ first call on our cash generation. This is especially important in a market characterized by inflationary headwinds and represents a strong commitment to our shareholders. And during the third quarter, I am pleased to announce we further built on our return of capital leadership by setting a new quarterly shareholder distribution record for our company corresponding to over 80% of our CFO and essentially 100% of our free cash flow to equity holders. Total third quarter shareholder distributions amounted to $1.2 billion, translating to an annual distribution yield of around 24%, a yield that’s not just at the top of the E&P peer space, but at the very top of the S&P 500. While we had guided third quarter return of capital to at least 50% of our CFO, due to strong operating and financial performance, our financial strength, including our replenished cash balance and favorable market conditions, including clear value in our stock price, we saw an opportunity to materially step-up the pace of repurchases. We bought back $1.1 billion of stock during the third quarter. The timing of our decision proved beneficial as third quarter buybacks were executed at an average price of around $24 a share, well below current trading levels.

Marathon also announced the acquisition of 130,000 acres in the Eagle Ford for $3 billion:

The transaction is immediately and significantly accretive to Marathon Oil's key financial metrics, expected to drive a 17% increase to 2023 operating cash flow and a 15% increase to free cash flow. The transaction was acquired at approximately 3.4x 2023 EBITDA and a 17% free cash flow yield, accretive relative to Marathon Oil's 2023 stand-alone metrics at the same price deck (4.7x EV/EBITDA, 13% FCF Yield). (Based off 2023 forward curve pricing of $81/WTI, $5.10/HH and $26.50/NGL as of 10/27/22; FCF assumes 15% cash tax rate: Based off 2023 forward curve pricing of $81/WTI, $5.10/HH and $26.50/NGL as of 10/27/22, MRO share price as of 10/27/22, MRO outstanding share count of 635 million, MRO net debt of $2.9 billion as at 9/30/22; FCF assumes 15% cash tax rate.)

Enhances Return of Capital Profile: As the transaction is accretive to Marathon Oil's cash flow profile, it will immediately enhance shareholder distributions, consistent with the Company's transparent Return of Capital Framework that is uniquely driven by operating cash flow and, in a $60/bbl WTI or higher price environment, calls for at least 40% of annual operating cash flow to be returned to equity holders. More specifically, Marathon Oil expects the transaction to increase 2023 shareholder distribution capacity by approximately 17%. Additionally, due to the cash flow accretive nature of the transaction, Marathon Oil expects to raise its quarterly base dividend an additional 11% post transaction close to 10ct/sh. Importantly, for full year 2022, Marathon Oil still expects to meet its objective to return at least 50% of adjusted operating cash flow to shareholders, outperforming its 40% framework minimum.

Marathon Oil expects to fund the transaction with a combination of cash on hand, borrowings on the company's revolving credit facility, and new prepayable debt. The Company does not expect the transaction to meaningfully affect its leverage profile, continuing to expect a net debt to EBITDA ratio of less than one, and coupled with enhanced enterprise scale anticipates positive credit quality implications.

It is really impressive that Marathon disclosed these metrics. I have never seen a company make an acquisition and affirmatively quantify that what they bought is cheaper than their own stock valuation. (It is also impressive that Marathon's own FCF yield is 13% at $81 oil and a $31 share price.)

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