Cenovus Energy Thoughts ($CVE)

Looking at Cenovus' results for the third quarter of 2024. 

Their upstream segment earned $1.9 billion of operating margin during the third quarter compared with $2.4 billion the prior year. The downstream segment had operating margin of negative $229 million during the third quarter compared with a positive $655 million the prior year.

Upstream capital expenditures were up 29% year-over-year, to $811 million for the third quarter. Upstream production volumes of liquids were 631k boe/d, down 3.4% year-over-year.

Cash from operations for the quarter was $1.76 billion and total capital expenditures were $956 million. That puts free cash flow at $804 million, for an annualized yield of 9.5% on the enterprise value of $34 billion.

During the third quarter, Cenovus spent $234 million on common share dividends and $520 million on share repurchases. The $754 million returned to shareholders is a shareholder yield of 10.4% on the current market capitalization of $29 billion (at a $16 share price). 

Here is where the math is going to be tricky for the fourth quarter, though:

During the third quarter, the price of WTI crude averaged $75/bbl and the 3-2-1 crack spread averaged around $19. With oil now at $70 and crack spreads at $16, results for Cenovus are going to be worse.

At 600k bbl/d of oil production, a -$5 per barrel decrease in the oil price will reduce revenue and free cash flow by $270 million per quarter or $1.08 billion per year. At 643k bbl/d of refining throughput, having crack spreads $3/bbl worse could cost $174 million per quarter or $694 million per year. [This calculations are both a bit fuzzy because things like crown royalties and input costs should go down with the oil price down.]

Assuming a hit of $1.08 billion on oil and $694 million on refining, Cenovus' annualized free cash flow would drop from $3.22 billion to $1.4 billion, which would only be a 4.2% yield on the enterprise value.

Cenovus' high cost refining (losing money when the crack spread is $19) is dragging down the results. The other major Canadian oil companies (Canadian Natural Resources, Suncor, and Imperial) generate much more earnings per barrel than Cenovus. 

We see others who are still bullish Cenovus. One of those pieces begins, "Assuming that management can improve the company's downstream performance..." Cenovus broke even in the third quarter in Canadian refining; the losses were in U.S. refining. Cenovus seems to have problems with the Lima (Ohio) refinery that came with its acquisition of Husky Energy in 2020.

Sometimes these things can't really be fixed. If you are running an airline with old, inefficient planes, you would never have results as good as a competitor with newer, more efficient planes. The more expensive jet fuel gets the worse you'll do in comparison. 

Amazingly, the Lima Refinery was opened in 1886 and is the oldest refinery in the United States. Cenovus got it in the acquisition of Husky Energy, and Husky bought it from Valero in 2007. Valero got it when they acquired a company called Premcor in 2005. Interesting that they sold it so soon afterwards.

Oil and Gas Earnings Notes (Q1 2024)

We wrote about Exxon, Chevron, and Imperial Oil earnings in a post last month. Now, let's look at our big Canadian producers (CNQ, SU, CVE), our royalty owners (DMLP and TPL; we already looked at PREKF results), and our two big refiners (MPC and VLO).

Canadian Natural Resources Limited
The current market capitalization of CNQ (at a $76 share price) is $81 billion, and the enterprise value is $88 billion. Cash from operations for the first quarter (results) was $2.12 billion and the company spent $773 million on capital expenditures. The remaining free cash flow for the quarter was $1.35 billion, which is a 6% yield on the enterprise value.

Capital expenditures were down 11.5% from the first quarter of 2023, while production of liquids was up 1.3% and total production (including natural gas) was up 1.1%. They averaged 976k bbl/d of liquids during the quarter. The realized price of oil per barrel was $52 for crude and $66 for synthetic crude, compared with $44 and $71 the prior year.

The company spent $796 million on dividends and $448 million on share repurchases for a shareholder yield of 6%. The diluted share count is down 2.9% year-over-year. Regarding capital allocation, management said on the conference call: "2024 marks an important milestone as we are delivering 100% of free cash flow to shareholders this year. And with strong crude oil strip pricing for the remainder of the year, we are targeting to generate significant free cash flow."

Suncor Energy Inc.
The current market capitalization of SU (at a $39.50 share price) is $51 billion, and with $10 billion of net debt, the enterprise value is $61 billion. Cash from operations for the first quarter (results) was $2.06 billion and the company spent $915 million on capital expenditures. The resulting free cash flow for the quarter was $1.15 billion, which is a 7.5% yield (annualized) on the enterprise value. During the quarter, Suncor returned $736 million via repurchases and dividends, for an annualized shareholder yield of 5.8%.

Capital expenditures were up 20% from the first quarter of 2023, while production was up 12.5%. They averaged 835k bbl/d of production during the quarter, which was a record, including all-time high oil sands production of 785k bbl/d from oil sands. Refining throughput of 455k bbl/d was also the highest in company history. The upstream segment earned $1.2 billion pretax and the refining and marketing segment earned $824 million, for a total of $1.2 billion of net after-tax earnings.

Cenovus Energy Inc.
The market capitalization of CVE is $37.5 billion (at a $20 share price) and their enterprise value is $43.4 billion. The upstream segment earned $1.2 billion of operating margin during the first quarter (results) (compared with $613 million the prior year) and the downstream (refining) segment earned $294 million (compared with $186 million earned the prior year).

Upstream capital expenditures were up 6.4% year-over-year, to $690 million for the first quarter. Upstream production volumes were 801k boe/d, up 2.8% year-over-year. Cash from operations for the quarter was $1.42 billion which puts free cash flow at $745 million, for an annualized yield of 6.8% on the enterprise value.

During the first quarter, the company spent $194 million on common share dividends and $122 million on share repurchases. The $316 million returned to shareholders is a shareholder yield of 3.4% on the current market capitalization. Net debt at the end of the quarter was $3.6 billion. Management has said that they will increase shareholder returns (from 50% of "excess free funds flow" to 100%) once net debt drops below $3 billion.

Dorchester Minerals, L.P.
The market capitalization of DMLP is now $1.3 billion (at $32 per unit). For the first quarter of 2024 (10-Q), the partnership earned $18 million of net income (compared with $28 million the prior year), generated $28 million of cash from operations (compared with $39 million the prior year), and distributed $40 million to unitholders. The CFO yield on the market capitalization is 8.6% (annualized). The annual shareholder meeting was on May 15 and the company has released the investor presentation. The most recent (second quarter) distribution was $0.782 cents, paid on May 9. Over the trailing four quarters, the partnership has distributed $3.31, which is a 10% yield on the current unit price.

Texas Pacific Land Corporation
The market capitalization of TPL (at $600 per share) is now $13.9 billion. (The company had a 3-for-1 share split during the first quarter.) The company has built up quite a cash pile during the shareholder activism dispute, so the current assets net of liabilities are $900 million and the enterprise value is $13 billion. The company owns 868,000 surface acres, which is an enterprise value of $15,000 per acre just for the surface.

In the first quarter of 2024 (10-Q), production volumes for TPL were 24,800 BOE per day, which was up 19% from the prior year. Their oil volumes at 0.99 million total barrels for the quarter were up 25% year-over-year. Oil and gas royalty revenue was up only 3.4% year-over-year because natural gas prices were down. Water sales, water royalties, and easement income were all up year-over-year, although the water service business has operating expenses, which were also up. (TPL's "land and resource management" segment had an adjusted EBITDA margin of 94% and its "water service and operations" segment had a 75% margin.)

Total expenses were $34.3 million (excluding depreciation) versus $38 million the prior year. Thankfully legal fees were only $4 million this quarter and not the $16.6 million spent in the year ago quarter. Expenses (again excluding depreciation) were 20% of total revenue, partly because TPL has established a "water services" business which is lower margin than collecting royalty revenue.

Operating income was $136 million for the quarter, and if you add back $3.8 million of depreciation, depletion, and amortization, you get a "cash flow-like number" of $140 million, which would be an annualized yield of 4.3% on the current enterprise value.  

The company published a May 2024 investor presentation as well as a presentation on produced water desalination and beneficial reuse.

Marathon Petroleum Corporation
This Marathon is the refiner, not the E&P company (MRO). They refine almost 3 million barrels per day, which is the most in the U.S., followed by Valero (VLO) and ExxonMobil (XOM), each with about 2 million barrels per day. 

At the current share price of $172, the market capitalization of MPC is $60.6 billion and the enterprise value is $82 billion. During the first quarter (release), Marathon's refining and marketing segment earned adjusted EBITDA of $1.9 billion and its midstream segment earned $1.6 billion, for total adjusted EBITDA of $3.3 billion. The refining capacity utilization was only 82% during the quarter, compared with 89% the prior year (when refining EBITDA was a much higher $3.9 billion).

Cash from operations was $1.5 billion and the company had $585 million of capex during the quarter. The company repurchased $2.2 billion of stock and paid $300 million of dividends, for total shareholder returns of $3 billion, a 20% annnualized shareholder yield. (The company's cash balance drew down by $2.3 billion as they outspent cash flow.)

Valero Energy Corporation
At the current share price of $157, the market capitalization of VLO is $51 billion and the enterprise value is $57 billion. During the first quarter (release), Valero's refining segment earned operating income of $3.5 billion and its renewable diesel and ethanols segments earned a combined$200 million.

Cash from operations was $1.85 billion and the company had $660 million of capex during the quarter. The company repurchased $1 billion of stock and paid $356 million of dividends, for total shareholder returns of $1.38 billion, an 11% annualized shareholder yield.

Earnings Notes II (Q4 2023)

Arch Resources Inc. (ARCH)
The market capitalization of Arch is $3 billion versus $2.8 billion last quarter. Their total liabilities less current assets are now $87 million, and current assets exceed current liabilities plus long term debt by $550 million. We would put the enterprise value at $3.1 billion now. Adjusted EBITDA was $180 million for the fourth quarter and $714 million for the whole year, which puts the EV/EBITDA at 4.3x using either mrq (annualized) or the full year.

For the full year 2023, Arch had cash from operations of $635 million. (Their net income plus depreciation, depletion, and amortization was $610 million.) Capital expenditures and investments in affiliates were $193 million. That gives free cash flow of about $430 million, which is a 14% yield on the enterprise value. They paid $206 million of dividends, bought back $125 million of stock, repaid $80 million of debt, and built their cash balance by $52 million.

Cenovus Energy Inc. (CVE)
The market capitalization of Cenovus is $33 billion (at a $17.5 share price) and their enterprise value is $40 billion. The upstream segment earned $1.8 billion of operating margin during the fourth quarter (compared with $1.6 billion the prior year) and the downstream (refining) segment lost $225 million (compared with $413 million earned the prior year). (See 2023 release and financials.)

For the full year, cash from operations was $5.5 billion versus $8.4 billion in 2022. Capital expenditures were $3.2 billion versus $2.7 billion the prior year. The "free funds flow," as they define it, was $3.3 billion versus $5.4 billion in 2022. The 2023 free funds flow is an 8.3% yield on the enterprise value. (There is room for this to be better if they get the downstream/refining operations straightened out.)

Capital expenditures for in their upstream segment were up flat year-over-year in the fourth quarter and were up 42% for the full year 2023 versus 2022. Liquids production in Q4 was flat versus the prior year, and liquids production for the full year was up 1%. Total upstream production (including natural gas) was flat in the fourth quarter and down 1% for 2023 versus 2022.
 
For the year, the company spent $950 million on debt repayment, $1.3 billion buying back shares and warrants, and $730 million on common share dividends. The share count (fully diluted) was down 4% year over year. The $3 billion returned is a 9% shareholder yield; however the company drew down its cash by $1.7 billion.

Net debt at the end of the year was $3.8 billion. Management has said that they will increase shareholder returns (from 50% of "excess free funds flow" to 100%) once net debt drops below $3 billion.

Genesis Energy LP (GEL)
This is a new midstream investment idea. Genesis has four segments: offshore pipelines in the Gulf of Mexico, carrying crude and natural gas produced offshore to refineries along the Gulf Coast; a soda ash business in Wyoming (like the business where NRP owns an interest); sulfur services (which removes sulfur from refinery inputs and sells it as sodium hydrosulfide); onshore pipelines and terminals; and a marine transportation business with boats and barges to transport crude oil and refined products.

The offshore pipelines contributed $407 million of operating income for 2023, soda and sulfur contributed $282 million, marine transportation did $110 million, and the onshore pipelines and terminals $28 million. Adjusted EBITDA for 2023 was $756 million. The market capitalization (@ $11) is $1.35 billion. Genesis has quite a bit of leverage: $3.75 billion of debt, and $814 million of convertible preferred units. (The distribution rate on the preferred units is 11.24%.) The enterprise value is thus $5.9 billion, and the EV/EBITDA is 7.8x. Guidance for 2024 is $680-$740 million of EBITDA and $200-$250 million of capex, which would mean anywhere from $430 to $540 of cash flow, which is a range of 7% to 9% on the enterprise value. 

Management thinks that cash flow is going to "ramp" from 2025 onwards as offshore volumes grow (with two new platforms coming online) as well as additional soda ash earnings. 

In addition to our record results in 2023, we also achieved some significant project milestones that will continue to benefit the partnership for many decades to come. First and foremost, we reached substantial completion and commissioned our Granger expansion project. This almost four-and-a-half-year construction project overcame many challenges and delays as a result of the Covid-19 pandemic, but I could not be prouder of our team on the ground in Green River, WY for their tireless effort getting this project to the finish line. This project will add approximately 750,000 short tons per year of additional soda ash production capacity at Granger, bringing its total production capacity to approximately 1.25 million short tons per year, and significantly lower Granger’s operating cost per ton, making it one of the most efficient and lowest cost production facilities in the world. I would also point out that Granger has multiple decades of reserves in the current seam at these new production rates along with hundreds of millions of tons of additional measured and indicated trona resources in those same seams.

As we mentioned last quarter, we also successfully laid the 105 miles of the SYNC pipeline in over 5,000 feet of water, which as many of you can imagine is an engineering marvel. This was a tremendous achievement and a testament to our offshore engineering, construction and operation’s teams that helped complete this portion of the project on schedule. In addition, we made significant strides in advancing our CHOPS expansion project, which includes installing pumps at certain strategic junction platforms. These offshore projects are long-term investments that are underpinned by existing upstream developments which have production profiles going out multiple decades, not years, and have ample capacity to handle much more than the currently discovered and contracted volumes.

Regarding uses of capital:

We opportunistically accessed the capital markets on two separate occasions in 2023 and successfully issued $500 million in new 8.875% notes due 2030 in January and $600 million in new 8.25% notes due 2029 in December, which allowed us to re-finance our 2024 and 2025 unsecured maturities, respectively. More importantly, the combination of these two re-financings ultimately triggered an automatic 12-month extension of our senior secured facility’s maturity date, which now expires in February 2026. These transactions have provided us with the financial flexibility and liquidity to complete our remaining spend on our major capital growth projects in 2024 and bridge us to 2025 when we expect to begin harvesting increasing amounts of free cash flow driven by both earnings’ growth and materially reduced growth capital expenditures. In addition, we utilized a portion of our available liquidity to opportunistically re-purchase $75 million of our Class A convertible preferred units throughout the year at a discount to the contracted call premium as well as purchase 114,900 of our Class A common units at an average price of $9.09 per unit.

Concluding an investment cycle is very powerful if it works: you get higher earnings and the capital expenditures decline, resulting in a big increase in free cash flow.

Lithia Motors, Inc. (LAD)
Thought this was interesting - Lithia announced that they are getting less interested in acquisitions:

Past practices prioritized acquisitions as more beneficial strategically than buybacks, but at our current size and scale, we are now returning to a balanced deployment of free cash flows to drive the strongest possible returns. We continue to monitor valuations of both, being patient for strong assets priced within our acquisition hurdle rates. We expect pricing to take some time to normalize and now estimate annual acquired revenues, excluding the Pendragon acquisition, in the range of $2 billion to $4 billion a year. Our near-term target of $50 billion in revenue remains within our sights, and our team is confident in our ability to achieve this while doing so in the most prudent fashion possible. Our team is experienced in executing and integrating acquisitions, and we remain committed to achieving strong returns as we build out our network.

Current market capitalization is $8.4 billion. They earned $1 billion for the full year. Something amazing is that LAD stock is up 165x from the 2009 low. That's compounding at 41%!

Canadian Oil Producer Earnings ($SU $CVE $CNQ)

[Previously regarding Suncor Energy, Cenovus Energy, and Canadian Natural Resources Limited.]

Canadian Natural Resources Limited
Once again, an outstanding result from the titan of the Canadian energy industry. Third quarter capital expenditures were up only 2.3% with liquids production up 5.2% year-over-year. Their production volume of 1.4 million BOE/d was the highest quarterly volume in the history of the Company.

Management said that "with current strong production volumes and expected free cash flow in Q4/23 and beyond, based on current strip pricing, we are quickly approaching a net debt level of $10 billion, which we forecast to achieve in Q1/24, at which time we target to increase returns to shareholders to 100% of free cash flow." The share count was down 2.4% year-over-year at the end of the third quarter - it would be nice to see the repurchases accelerate.

The current market capitalization of CNQ (at a $67 share price) is $73 billion, and the enterprise value is $82 billion. Cash from operations for the third quarter was $2.6 billion and the company spent $875 million on capital expenditures. The remaining free cash flow for the quarter was $1.7 billion, of which $534 million was used for debt repayment, $718 million was used for dividends, and $434 million was used for share repurchases. The free cash flow yield on the enterprise value was 8.3% based on the quarter's results. 

This was during a quarter with an average WTI price of $82 and an averaged realized price for liquids by CNQ of $64. In its latest investor presentation, CNQ says that free cash flow per share would be 30% higher at $100 WTI than at $85 WTI. (Notice also on slide 8 of the presentation, CNQ management points out that oil sands mining and upgrading requires much less capital expenditure to maintain production than shale.)

On the CNQ conference call, management was asked (by the Goldman Sachs analyst Neil Mehta) whether they were interested in M&A in Canada. The CEO said that "we have a huge reserve base... we don’t have to do any acquisitions to create or find more reserves, so we have that part in the bag."

Suncor Energy Inc.
The current market capitalization of SU (at a $32.50 share price) is $42 billion, and the enterprise value is $51 billion. Cash from operations for the third quarter was $3 billion and the company spent $1.1 billion on capital expenditures. The remaining free cash flow for the quarter was $1.9 billion, of which $1.3 billion was used for debt repayment, $489 million was used for dividends, and $217 million was used for share repurchases. The free cash flow yield on the enterprise value was 14.9% based on the third quarter's (annualized) results. The shareholder returns (repurchases and dividends) for the quarter are a 6.7% shareholder yield. The company has bought back 3.5% of shares outstanding YTD. Suncor's earnings per share were 86 cents, so a P/E of 9x. 

Funds from operations were down versus the third quarter of last year, but up significantly from the second quarter of this year. One key performance metric was that refinery utilization was 99% for the quarter instead of 85% the prior quarter.

Some highlights from the conference call:

*On October 3, we announced a revised deal to acquire Total Canada for $1.468 billion. This is an improved deal versus the original deal. Specifically, we no longer have a contingent payment provision in the acquisition. Similar headline valuation to the earlier Teck deal, but we’ve got additional benefits. Commercial patience and persistence were key here, and we’re pleased with the deal. We’re on track to close the transaction later this month. It addresses long-term bitumen supply uncertainty associated with our upgraders, fills our upgraders for the long-term, but also enables additional value creation, value creation through regional synergies, with mobile equipment deployment, value creation through directing higher yield PFT from Fort Hills to our upgraders, a number of incentives and, as I said, we’re quite pleased with the deal.

*Let me move on to mining fleet performance for context. The cost of physically moving ore from the face of a mine to a crusher for the start of extraction, that’s our single highest cost component in the production of bitumen. Today, we move about 1.3 billion tons of earth per year to support production, and we’ve got a competitive cost gap versus best-in-class, comprehensive efforts to lower our cost per ton. The winning formula, fewer trucks, bigger trucks, more efficient trucks, and, of course, companion or compatible shovels, that’s our mining improvement strategy in a nutshell. So, this year and throughout 2024, we will add via a combination of purchase and lease 55 ultra-class 400-ton trucks to our total fleet, displacing nearly twice as many smaller third-party, less efficient, higher cost vehicles. Each truck will be pre-equipped for ultimate driverless or autonomous operation. The cost for these acquisitions and leases are in our guidance for this year, as well as our guidance that we’ll issue shortly for 2024. Once in place, this action alone is expected to lower our overall corporate breakeven by $1 a barrel.

*I suspect you’ve noticed a few references today in terms of per barrel. This reflects a new and evolving vocabulary within the company, thinking about and communicating the impact of our actions, plans, and improvements in unit per barrel terms. In addition, a subset of us similarly talk about the impact in per share terms. Our vocabulary is part of creating clarity and focus, developing a results-oriented, high-performance culture.

The oil sands segment generated funds from operations for the third quarter of $1.27 billion, with a sales volume of 656 thousand barrels per day and an average crude price realization of $74/bbl.

The refining and marketing segment generated funds from operations of $1.1 billion, processing 463 thousand barrels per day and making a gross margin (LIFO) of $31 per barrel.

Cenovus Energy Inc.
The market capitalization of Cenovus (CVE) is now $33 billion (at a $17.5 share price) and the enterprise value is $40 billion. The upstream segment earned $2.5 billion of operating margin during the third quarter (compared with $2.1 billion the prior year quarter) and the downstream (refining) segment earned $673 million (compared with $358 million).

Their free cash flow (as we define it, CFO less capex) was $1.24 billion for the quarter, which gives a free cash flow yield on the enterprise value of 12.4%.

In the third quarter, the company returned $876 million to shareholders by way of $438 million for the partial payment of the common share warrants obligation, the repurchase of 13.8 million shares for $264 million, and $193 million of common dividends. The shareholder yield on the market cap was 10.6% (annualized).

The company also repaid $973 million of debt. Cenovus’s shareholder returns framework has a target of returning 50% of excess free funds flow to shareholders for quarters where the ending net debt is between $6.5 billion and $2.9 billion. (Net debt is down to $4.3 billion as of the end of the third quarter.)

Capital expenditures for the third quarter in their upstream segment were up 74% year-over-year while production of crude oil was up only 3%. For the current year-to-date, the upstream capital expenditures are up 68% while crude oil production is up only 1% compared to the first nine months of last year.

Canadian Oil Earnings ($CVE $SU $CNQ $PREKF)

[Previously regarding Suncor Energy, Cenovus Energy, Canadian Natural Resources Limited, and PrairieSky.]

Suncor Energy: the market capitalization is now $41 billion (at a $31.5 share price) and the enterprise value is $53 billion. They reported earnings for the second quarter of 2023 of $1.4 billion (figures in USD), which means that shares are trading for seven times net (annualized) earnings. This was with an average WTI crude oil price of $73.75/bbl for the quarter, a $15/bbl discount for WCS, and a $2.90/bbl premium for Syncrude.

Upstream production was up 3% year-over-year, from 720k bbls/d in Q2 2022 to 742k bbls/d this quarter. Upstream capital expenditures were up 20% year-over-year, for a "production shortfall" of 17%. (Compare with shale players like OXY, where the production shortfall in the Permian this quarter was 51% or Devon, which had a production shortfall of 80%.)

Suncor's free cash flow for the quarter was $782 million, which is a 6% yield on the current enterprise value. They returned $1.04 billion to shareholders during the quarter, equally split between share repurchases and dividends, for a shareholder yield of 10% (annualized). The refining operating income was down 75% y/y even though their proprietary Suncor 5-2-2-1 index (crack spread) was only down 33%.

Cenovus Energy: the market capitalization is now $37 billion (at a $19.70 share price) and the enterprise value is $45 billion. They reported earnings for the second quarter of 2023 of $643 million (figures in USD), which means that shares are trading for 14 times net (annualized) earnings.

Upstream production was down 4% year-over-year, from 762k bbls/d in Q2 2022 to 730k bbls/d this quarter. Upstream capital expenditures were up 61% year-over-year, for a "production shortfall" of 57%. (Note that the production levels were reduced by wildfires in Alberta this year, which explains part of the shortfall.)

Cenovus's free cash flow for the quarter was $741 million, which is a 7% yield on the current enterprise value. They delivered $427 million to shareholders in the second quarter through buybacks and common share dividends; plus they repurchased 45.5 million of their outstanding warrants for $528 million.

Canadian Natural Resources: the current market capitalization (at a $61.76 share price) is $67 billion, and the enterprise value is $76 billion. They reported earnings for the second quarter of 2023 of $1.1 billion, which means that shares are trading for 15 times annualized earnings. 

Upstream production was down 1.6% year-over-year, from 1.21 million BOE/d a year ago to 1.19 million this quarter. Capital expenditures (CNQ has no downstream) were up 15% year-over-year, for a "production shortfall" of 17%.

CNQ's free cash flow for the quarter was $807 million, which is a 4% yield on the current enterprise value. They delivered $1.1 billion of shareholder returns, comprised of approximately $742 million of dividends and approximately $370 million of share repurchases, for a shareholder yield of 6.6%.

PrairieSky: the market capitalization of Prairie Sky (at $19.50 per share for the U.S. ADR) is $4.7 billion and the enterprise value with $216 million of net debt is $4.9 billion. They reported earnings for the second quarter of 2023 of $36 million, which means that shares are trading for 33 times net (annualized) earnings.

Realized pricing was down 37% y/y and production was down 10% y/y (although oil production was actually up 3%) resulting in revenue down 40%.

Cash from operations was $71 million for the quarter, a 6% yield on the current enterprise value.

"Cenovus announces repurchase of 84% of its outstanding warrants" ($CVE)

Announcement today:

Cenovus Energy Inc. (TSX: CVE) (NYSE: CVE) has reached separate agreements with each of Hutchison Whampoa Europe Investments S.à r.l. (HWEI) and L.F. Investments S.à r.l. (LFI) to purchase for cancellation all of the warrants held by HWEI and LFI, respectively, representing an aggregate of 45,484,672 warrants (CVE.WT), for $711 million in the aggregate (the Warrant Repurchase Transactions). As part of Cenovus’s combination with Husky Energy Inc., each Husky shareholder received 0.7845 of a Cenovus common share plus 0.0651 of a Cenovus common share purchase warrant in exchange for each Husky common share, with each whole warrant having an exercise price of $6.54 per common share, expiring January 1, 2026.

The price to be paid for each warrant pursuant to each Warrant Repurchase Transaction represents a price of $22.18 per common share, less the warrant exercise price of $6.54 per common share. The warrants will be cancelled at close, which is expected to occur later today. The company has negotiated payment terms that provide flexibility to work within its shareholder returns framework, with no expected impact to Cenovus’s ability to achieve its $4.0 billion net debt target. At its discretion, Cenovus has the option to pay the aggregate warrant purchase price of $711 million for the combined Warrant Repurchase Transactions through the remainder of 2023, within each quarter’s excess free funds flow, with full payment being made no later than January 5, 2024.

The 45,484,672 warrants cancelled as part of the Warrant Repurchase Transactions would, if exercised, represent approximately 2.4% of Cenovus’s total common shares outstanding. This transaction represents a repurchase of 84.1% of the warrants that remain outstanding. HWEI and LFI will continue to own 316,927,051 common shares (16.7%) and 231,194,699 common shares (12.2%), respectively, of Cenovus’s issued and outstanding common shares.

“This is a unique opportunity for Cenovus to continue to enhance shareholder returns by acquiring these warrants at a discount to the market price,” said Jon McKenzie, Cenovus President & Chief Executive Officer. “The agreements reached separately with HWEI and LFI benefit all Cenovus shareholders. Both HWEI and LFI are committed, long-term Cenovus shareholders and we continue to value each entity’s support and confidence in our company.”

Canadian Oil Sands Earnings - Suncor and Cenovus ($SU $CVE)

[Previously regarding Suncor Energy and Cenovus Energy.]

Suncor Energy: the market capitalization is now $38 billion (fully diluted, at a $28 share price) and the enterprise value is $48 billion. They reported earnings [pdf] for the first quarter of 2023 of $1.5 billion (figures in USD), which means that shares are trading for just over six times net (annualized) earnings. Their adjusted funds from operations for the quarter were $2.2 billion, which gives an annualized AFFO/EV yield of 18%. This was with an average WTI crude oil price of $76/bbl for the quarter, a $24.75/bbl discount for WCS, and a $2.1 premium for Syncrude.

Suncor's earnings held up much better than the shale companies' earnings. Upstream earnings went from $1.6 billion in Q4 to $1.4 billion in Q1. Downstream (refining and marketing) earnings went from $1.1 billion to $725 million. Having a lower production cost and having downstream businesses reduces the leverage to the oil price. 

During the first quarter, Suncor spent $800 million on capital expenditures compared with $638 million on share repurchases and $500 million on dividends. That gives a shareholder yield (annualized) of 12% on the current market capitalization. From the end of Q1 through May 5th, Suncor repurchased more than 8 million shares which is 0.66% of the outstanding.

As we mentioned in the post about Marathon and Occidental, Suncor's oil sand production in the first quarter was down about 2% and total upstream production was down 3% versus the prior year. That was with total capital expenditures up 6%, oil sands capex up 21%, exploration and production capex up 66%, and total upstream capex up 26%.

In the most recent annual information form (PDF, 2022), Suncor gives the estimated net present value of its proved plus probable reserves, after income taxes and at a 10% discount rate, as $39 billion. This is lower than the estimate of $50 billion at the end of 2021, primarily because the commodity price has fallen. That ignores the value of the refining and market business, which earned an average of $3.1 billion/year over the past two years. Suncor also estimates that they have 5.5 billion barrels of oil equivalent of proved and probable reserves, which is an enterprise value of under $9 per barrel. (Note, that is a 20 year reserve life at the current production level of 270 million barrels per year.)

One last development that came out today is that ConocoPhillips has elected to exercise their right of first refusal with respect to the Surmont asset that Suncor is buying from Total. Suncor said that their agreement to close the transaction was conditional upon ConocoPhillips waiving its right of first refusal, and so they will be "assessing the transaction in light of this change."

Cenovus Energy: the market capitalization is now $32 billion (at a $16.70 share price) and the enterprise value is $37 billion. They reported earnings [pdf] for the first quarter of 2023 of $464 million (figures in USD), which means that shares are trading for just over 17 times net (annualized) earnings.

The company had a disappointingly weak first quarter. The upstream was hurt by the lower oil price and lower production volumes. Downstream margin was 30% lower than in the fourth quarter due to various refining problems. Their adjusted funds from operations for the quarter were $1 billion, which gives an annualized AFFO/EV yield of 11%.

During the first quarter, Cenovus spent $800 million on capital expenditures, $84 million on debt repayment, $29 million on share repurchases, and $146 million on common share dividends - a pitiful shareholder yield.

Capital expenditures in the upstream segment were $639 million for Q1 2023 versus $377 million in Q1 2022, an increase of 70%. (Downstream capex was flat.) The oil sands production was down about 1% y/y, liquids production was down 3%, and total upstream production was down 2.5%. The oil sands capex specifically was up 69% year over year. 

Cenovus did say that "oil sands production expected to be stronger in the second half of the year due to pad timing". However, if you look at slide 11 of the investor presentation [pdf], they give an estimated incremental production of 125k bbl/d from various growth and optimization expenditures in the upstream. That would be 16% growth, but it is expected to happen over a multi-year period.

We are going to be paying close attention in the second quarter to whether the big increases in capex at oil companies are having any effect on production volumes. So far, Suncor seems to be the best of the producers in terms of the capex required to maintain production. Overall, what we saw in results this quarter seems bearish for most producers and bullish for the oil price and for royalty companies.

Energy - Q4 2022 Earnings Season

Oil prices have been in a drawdown since they peaked at $123.70 per barrel in March of last year (with an echo peak in June in the $120 per barrel range). As energy investors, we have been fighting two headwinds:

• The Federal Reserve has been shrinking its balance sheet (tightening) since last April. From a peak of $8.96 trillion, it has declined 6%. We have seen since 2008 that the Fed's attempts to shrink its balance sheet (i.e. "taper") are bearish for risk assets. They have also been short lived, and associated with rebounds that are much larger than the amount of reduction, which is why the balance sheet has grown over time and is an order of magnitude larger than it was twenty years ago.
• Releases of oil from the Strategic Petroleum Reserve have averaged about 600,000 barrels per day over the past year. The liquidation of crude oil inventories is unprecedented and will necessarily eventually end.
  

It will be interesting to see what happens when all of the world's economies are fully reopened, there are no more liquidations of SPR or commercial inventory, and the Federal Reserve (together with other central banks) resumes printing instead of tightening. 

Our view is that eventually all three of those factors will be acting as tailwinds and not headwinds, and that when they are it will be bullish for oil. We just do not know when those stars will all align. (Fed Funds futures currently predict that rates are most likely peak this June, although possibly as late as December. If the SPR were to continue selling at a rate of 600k bbl/d, it would be completely exhausted in under two years.)

Since we do not know when an oil bull market will resume, and we also do not know what price oil will sell for over the long term, it is instructive to see what our energy companies are earning now, at recent commodity prices and refining margins. Fourth quarter results can give us a good look at this, and earnings results are out for Suncor, Cenovus, and Marathon. (We are still waiting for Canadian Natural Resources, which does not report results until March.)

Suncor's market capitalization is $45 billion (at a $34 share price) and the enterprise value is $55 billion. They reported earnings [pdf] for the fourth quarter of $2 billion, which means that shares are trading for under six times net (annualized) earnings. Their adjusted funds from operations for the quarter were $3.1 billion, which gives an annualized (Q4) AFFO/EV yield of 23%. 

Suncor claims to have 7 billion barrels of proved and probable reserves, which is an enterprise value of less than $8 per barrel. The PV-10 of their proved and probable reserves was $50 billion at the end of 2021, which was calculated based on the $66.56 average WTI price that year. Keep in mind in addition to the value of the upstream reserves (which are worth almost the entire enterprise value at a lower oil price than today), Suncor also has its refining and marketing operations, which earned $4.2 billion in 2022.

The shareholder returns are also very impressive. Suncor spent $3.7 billion on capital expenditures last year, versus $2.7 billion on debt repayment, $3.8 billion on share repurchases, and $1.9 billion on dividends. The combined amount spend on debt, buybacks, and dividends was $8.4 billion, which is 19% of the current market capitalization. (The shares repurchased during 2022 were equal to 8% of the beginning of year share count.) Suncor said that they expect to increase their share buyback allocation to 75% of "excess funds," meaning whatever is left over after capex of $4 billion and a dividend of $2 billion ($1.53 per share; a 4.5% yield, by the end of the first quarter of 2023. (The other 25% would continue to be spent on debt reduction, until a target of a $6.7 billion "debt floor" is reached.

Cenovus's market capitalization is $36 billion (at an $18.50 share price) and the enterprise value is $39 billion. They reported earnings [pdf] for the fourth quarter of $580 million and $4.8 billion for the full year, which means that shares are trading for 7.5x last year's earnings. Their adjusted funds flow for the fourth quarter was $1.7 billion, which gives an annualized (Q4) AFFO/EV yield of 17%. Cenovus had some issues with third-party pipeline outages during the quarter that impacted their downstream (refining) operations.

According to the company: "at the end of 2022, Cenovus total proved reserves were relatively unchanged at approximately 6.1 billion BOE, while total proved plus probable reserves increased 7% to approximately 8.9 billion BOE." That makes for an enterprise value per barrel of 2P reserves of under $5 per BOE.

Last year's capital allocation and shareholder returns were impressive. They spent $2.7 billion on capital expenditures for the whole year. Meanwhile, they reduced their net debt to $3.2 billion, which was a decline of $4 billion year over year and $740 million from the prior quarter. They spent $667 million on dividends and $1.9 billion on share repurchases (which was enough to buy back 6% of the beginning of year share count). The combined amount spend on debt, buybacks, and dividends was $5.6 billion, which is 16% of the current market capitalization. They think that by the fourth quarter, net debt should be below the "floor" of $3 billion, at which point they would target "100% shareholder returns" using excess free funds flow.

Marathon Oil Corporation's current market capitalization (at a $26.75 share price) is $17 billion and their enterprise value is $20 billion. They reported earnings for the fourth quarter of $525 billion, which means that shares are trading for 8 times annualized earnings. Free cash flow was $763 million for the quarter which is an annualized (Q4) FCF/EV yield of 15%.

They delivered total shareholder returns of $3.0 billion, representing a distribution yield of 17% on the current market capitalization, including $338 million during the fourth quarter. Most of this was done via share repurchases (totaling $2.8 billion), which resulted in a 15% reduction in outstanding shares. They generated approximately $4 billion of free cash flow for the year and the $3 billion which was returned is 75%; higher than Suncor or Cenovus. The 2023 capital budget and guidance is for $2 billion of capex and $2.6 billion of adjusted FCF, assuming $80 oil and $3 natural gas.

It is interesting to compare the results that these three companies had with a competitor, Devon Energy, which also reported earnings this week. Their capital expenditures were up 80% (Q4 2022 versus Q4 2021) but their production was only up 4%. 

It is good to see a shale producer and competitor exhibiting deteriorating economics. This is why we are interested in royalties and resources with front-loaded costs and long reserve life.

Devon has a market capitalization of $42 billion and an enterprise value of $47 billion. Free cash flow for the fourth quarter was $1.1 billion which was the same as the year prior. It is also interesting that Devon's FCF/EV yield (annualized) is only 9%. It goes to show that other investors do not realize how superior royalty investments and long reserve life investments with front-loaded costs will be in an inflationary environment.

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.)

Cenovus Reports Q2 2022 Earnings ($CVE)

[Cenovus Energy is the third largest Canadian oil and natural gas producer and the second largest Canadian-based refiner and upgrader. See our past posts: Long Reserve Life Oil: Cenovus Energy Inc., followed by Cenovus Reports Q3 2021 Earnings ($CVE), Canadian Oil Sands Earnings (Suncor and Cenovus) - Q4 2021, Goldman Sachs on Suncor and Cenovus, and Cenovus Reports Q1 2022 Earnings.]

Cenovus is trading for slightly less per share ($19.00 vs $19.40) than it was one quarter ago when we wrote up the previous earnings notes. That makes for a market capitalization of $37 billion and an enterprise value of $43 billion using their definition of net debt (which is currently $6 billion, down from $6.6 billion one quarter ago).

For the second quarter, Cenovus had net income of $1.9 billion, EBITDA of $3.4 billion, and FCF of $2.8 billion (all figures USD). If you annualize those figures, you see that the company is trading for under 5x net income and the FCF/EV yield is 26%. (You'll notice that the company is not very leveraged, with a debt/EV of only 14%.

During the second quarter, the oil price was nice and high (higher than it is at the moment) and crack spreads (which dictate the refining profits) were at record highs as well. Counteracting those benefits were the company's hedges, which they completely closed during the second quarter. The hedges were responsible for a $220 million loss during the quarter. If oil prices stay below where they were during Q2 this quarter, Cenovus will likely be less profitable this quarter, even without the hedging losses. (On the other, other hand, Cenovus' guidance for the remainder of the year is that production will be a little higher.)

Some highlights from the Q2 conference call:

In terms of our financial results, the quarter's adjusted funds flow of $3.1 billion was the highest in Cenovus' history. Free Funds flow was $2.2 billion and excess free funds flow was also about $2 billion. Given net debt was between $9 billion and $4 billion at the end of Q1, we've allocated about 50% of Q2 excess free funds flow towards shareholder returns, which is over and above our base dividend. As such, we delivered over $1 billion to shareholders through share buybacks in the second quarter.

As I've talked about before, share buybacks are the preferred mechanism for variable returns, at least when our share price is around the range it has been recently. We will continue to look at share buybacks on an opportunistic and disciplined basis with a view to intrinsic value at mid-cycle pricing of around $60 WTI. [...]

So if you see the share price of $16 [in CAD, which is $12.50 U.S.] and we got a lot of spare cash, no one should be terribly surprised to see us focused on shareholder returns and vice versa, if we're at $30 [in CAD, $23 U.S.], we'll probably be focusing on variable dividends. But the real important commitment is between 9 billion and 4 billion [of CAD debt, which is $7 billion to $3 billion U.S.], 50% of that is going to shareholders. And once we hit four [billion of debt], it's a 100%. [...]

I'm a simple guy, and I'm not sure the world has changed that much. A lot of people in my position have gotten a lot of trouble by assuming we're in a new era of commodity prices. We still think there are times in the cycle where oil can get to $45 or potentially even below. We don't think the world works at $45 oil. So -- but we still -- I still think those fundamentals apply. A lot of oil can be brought on in this world for $60. And for the time being, we're going to continue with that -- I mean, potentially conservative outlook, but that's really the discipline we're applying here.

That is interesting that management is saying that they think that shares would be fairly valued at $23 (currently $19) assuming $60 "mid-cycle" oil. That tells you that they are probably quite attractive at the current price, and all the more so if you think that inflation, production bottlenecks, ESG capital deprivation, and shareholder-imposed capital discipline are going to preclude $60 oil from happening again. In other words, if you think that the cost of production has taken a step higher, both in nominal and real terms.

Remember there are also the Cenovus warrants, which were issued to Husky shareholders when Cenovus acquired them. The warrants expire in January 2026 and have a strike price of CAD$6.54 (or US$5.10). With the CVE shares at $19, the intrinsic value of the warrant is $13.9 and they trade for $14.10. 

We like Canadian oil sands investments because of the long reserve lives and the somewhat front-loaded (therefore somewhat inflation-resistant) costs of production, as well as the low cost of production, and high free cash flow conversion at these oil prices.

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 under $6/bbl 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).

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.

Goldman Sachs on Suncor and Cenovus

Suncor Energy Keeps Buy Rating at Goldman Sachs as it Expects Oil Sands Operations to Improve

Goldman Sachs on Wednesday kept its rating on Suncor Energy at buy with a US$38.00 target price as it sees concerns over the reliability of the oil producer and refiner's oil sands operations beginning to wane.

"While SU has substantially lagged over the past few years around management concerns and operational execution, we see room for an inflection in performance as the company progresses through its operational improvements, with SU most recently announcing a change in Mining/Upgrading leadership. While we highlight SU guided to lower volumes on the most recent earnings call, we still see SU trading at a 24% FCF Yield for the year, even with GS at the low-end of SU 2022 volume guidance. We also highlight the stock's peer leading dividend yield of 4.1%, and with SU offering a ~13% 2022 capital returns yield (Canada average of ~12%). Overall, we see 20% total return to SU."

Cenovus Energy Keeps Buy Rating From Goldman Sachs on Expected High Returns

Goldman Sachs on Wednesday reiterated its buy rating on the shares of Cenovus Energy ( CVE ) with a US$19.00 target price as it expects "noise" for the shares of the oil producer and refiner as ConocoPhillips' (COP) continues with plans to sell down its stake in the company,, which stood at around 100-million shares in January.

"We expect CVE performance to inflect, as technical overhangs roll off, including COP's sell-down, as well as CVE contingent payments to COP and noise around hedging/earnings execution," the investment bank noted. "We highlight COP is expected to exit their CVE ownership this quarter, per COP guidance, and also note CVE contingent payments to COP will end in 2Q22. While certain investors have also highlighted the company's hedging strategy as a potential headwind, we note CVE still exhibits a strong 2022 FCF yield of 29%, even after considering hedges. Additionally, we expect a positive rate of change in US Refining, with a more constructive macro setup and following heavy turnaround in 2021. Overall, we see 17% total return to CVE."

Canadian Oil Sands Earnings (Suncor and Cenovus) - Q4 2021

[Previously regarding Canadian oil sands majors: Long Reserve Life Oil: Cenovus Energy Inc., Suncor Energy Inc., Cenovus Reports Q3 2021 Earnings, Canadian Natural Resources Limited.]

Suncor (SU) reported results last week. Highlights from the results:

• Suncor's total upstream production was 743,300 barrels of oil equivalent per day (boe/d) in the fourth quarter of 2021, compared to 769,200 boe/d in the prior year quarter, with the decrease primarily due to decreased production from the company's Exploration and Production (E&P) assets, including the absence of production from the Golden Eagle Area Development, as the sale of the asset was completed early in the fourth quarter of 2021. The company's synthetic crude oil (SCO) production was 515,000 barrels per day (bbls/d) in the fourth quarter of 2021, comparable to 514,300 bbls/d in the fourth quarter of 2020, driven by combined upgrader utilization of 96%.
• Refining and Marketing (R&M) delivered $765 million in adjusted funds from operations in the fourth quarter of 2021, compared to $415 million in the prior year quarter, including a first-in, first-out (FIFO) inventory valuation gain of $106 million after-tax in the current period compared to a gain of $44 million after-tax in the prior year quarter. 
• In 2021, Suncor executed on its net debt reduction targets, reducing debt at the highest ever annual pace, resulting in a reduction of net debt by $3.7 billion to $16.1 billion, returning to 2019 net debt levels. 
• Suncor returned $3.9 billion to shareholders in 2021 through $2.3 billion in share repurchases and $1.6 billion in dividends paid, including an increased dividend in the fourth quarter of 2021, returning it to 2019 levels. Since the start of its current normal course issuer bid program (NCIB) in February 2021, the company has repurchased approximately 84 million of its common shares at an average price of $27.45 per common share, or the equivalent of 5.5% of Suncor's public float as at January 31, 2021.
• The company’s 2021 capital expenditures were heavily focused on the safety, long-term reliability and efficiency of the company’s operating assets. Looking ahead, enabled by efficiencies achieved across the business and the company’s commitment to capital discipline, in 2022 the company expects to achieve capital expenditures of $4.7 billion, or $300 million (6%) lower than the previously announced ceiling of $5.0 billion, with a program largely focused on sustaining capital including planned maintenance and tailings optimizations.
  

Net debt fell from $19.8 (CAD) billion to $16.1 billion during the year. As @HFI_Research tweeted, "Incredible to think $SU given how much FCF it will generate is actually prioritizing debt pay down over dividend or share buyback increase. I understand the debt reduction thing because we are doing it at Gear. But they are one of the few 'haves' that can actually borrow." SU can borrow for 30 years at 3.7%; their latest maturity right now is March 2051. I guess at some point if this keeps going they will run out of debt to repay.

Some highlights from the Q4 conference call:

• We returned nearly $4 billion of cash through the doubling of our dividend and share buybacks, and that's 40% of our adjusted funds from operations within the year. Based on our average 2021 average market cap, that's a 10% [shareholder yield]. Looking at our 2021 full year performance, Suncor generated adjusted funds from operations of $10.3 billion. Our regional oil sands assets contributed record annual funds from operations of $6.9 billion, despite completing the largest maintenance program in our history.
• Our 2021 full year capital spend of $4.4 billion was within the provided guidance range, but higher than our previously communicated midpoint of $4.2 billion. This was due to increased spend at Syncrude and Firebag late into the year as a result of the operational issues, the earlier receipt of materials for 2022 turnarounds as we manage supply chain and accelerated progress payments on the co-gen as milestones were achieved slightly faster than expected. 
• In terms of shareholder returns, during the quarter, we returned $1.2 billion to shareholders in the form of dividends and buybacks, and at the same time, reduce our net debt by roughly $500 million. On a full year basis, we returned nearly $4 billion to shareholders and repaid nearly $4 billion of debt. As a result, we reduced the number of outstanding shares back to 2015 levels and returned our dividend and net debt balance back to 2019 levels. As it relates to our guidance, our only change is to the business environment for higher commodity prices, which of course, increases our cash tax and royalty ranges slightly.
• On the capital allocation, after dividends and the capex, we're allocating our free cash flow 50-50 between buybacks and debt reduction. So we would expect to see a similar, if not higher, cash return to shareholders than you saw in 2021 based on current strip prices.
  

For the fourth quarter, Suncor's cash from operations (excluding changes in working capital) was $3.1 billion and its capital expenditures were $1.4 billion, for free cash flow of $1.8 billion. (Which was up 50% from Q3 2021.) That's just for the quarter: annualized that would be $7.2 billion. (Figures up to this point have been CAD$.) The current FCF yield on the enterprise value is around 11% given last quarter's average $87/bbl price of crude oil. Note that they are planning to invest less than 40% of operating cash flow this year and return the rest to shareholders and repay debt - this is the same fraction as Peabody Energy.

Cenovus (CVE) also reported results last week. Highlights:

• [R]ecord oil sands production in the fourth quarter of 2021, contributing to total upstream output of more than 825,000 barrels of oil equivalent per day (BOE/d) and almost 792,000 BOE/d1 for the full year.
• The company generated fourth-quarter cash from operating activities of $2.2 billion and adjusted funds flow of $1.9 billion. With free funds flow of $1.1 billion in the quarter, and proceeds from recent divestitures, net debt was below $9.6 billion at year end, a reduction of more than $1.4 billion from the end of the third quarter and $3.5 billion in 2021 following the acquisition of Husky Energy. Total long-term debt was $12.4 billion as at December 31, 2021, down nearly $1.7 billion from January 1, 2021...
• Cash from operating activities was $2.2 billion and adjusted funds flow was $1.9 billion in the quarter. Free funds flow of $1.1 billion included capital investment of $835 million primarily for planned winter drilling programs in the Oil Sands and Conventional segments as well as the Superior Refinery rebuild project. Cash flows were impacted in the fourth quarter by a realized risk management loss of $268 million related to Cenovus’s inventory risk management program compared with a realized risk management loss of $184 million in the third quarter. 
• Cash from operating activities was nearly $6 billion for the year, compared with $273 million in 2020. Adjusted funds flow was $7.2 billion and free funds flow was $4.7 billion. Total capital expenditures for the year were approximately $2.6 billion, primarily concentrated on sustaining production at the company’s upstream assets and maintenance capital for the downstream assets, as well as investment in the Superior Refinery rebuild. 
  
• Cenovus’s proved and probable reserves are evaluated each year by independent qualified reserves evaluators. At the end of 2021, Cenovus’s total proved reserves rose 21% to approximately 6.1 billion BOE, while total proved plus probable reserves increased 24% to approximately 8.3 billion BOE largely due to the Husky transaction. Total proved bitumen reserves were approximately 5.6 billion barrels, an increase of 16% from 2020, while total proved plus probable bitumen reserves rose 17% to approximately 7.4 billion barrels. At year-end 2021, Cenovus had a proved reserves life index of approximately 21 years, and a proved plus probable reserves life index of approximately 29 years.
  

Highlights from the Q4 conference call:

• We’ve delivered on everything we’ve set out to do, including successful integration of the Husky business delivering over and above our targets for upstream operations, Canadian downstream, transaction synergies, asset sales, net debt reduction, and increasing shareholder returns. Now, assuming commodity prices continue to hold, we will rapidly hit our net debt target of 8 billion, implying we could be looking at even more free funds flow to allocate in 2022. I assure you, we will continue the capital discipline you’ve come to expect from us.
• One of the things that we did see in December in particular was some pretty weak pricing, both WTI as well as the WTI, WCS spread and so we did take an opportunity to build some inventory and not sell in December, and some of those sales will be reflected in January and February of this year.
• I think first off my observation is that our NCIB program, I think, has been a reasonably effective offset to Conoco’s action selling down their block. I mean, at this point, you guys have heard me say this so many times that it sounds pretty rote but we’re always happy to work with them, we haven’t really found any opportunities to a coordinate and it’s made a little bit difficult by the rules, but as long as the pricing works for us with our NCIB program, we think that that remains a pretty effective offset to their sell down.
• I’m kind of old enough and bear enough scars that I guess when it comes to pricing, I’m always very cautious. We anchor all of this company’s development plans at the bottom of the cycle for oil and gas. We won’t invest in a project that doesn’t deliver an acceptable return at the bottom of the cycle, which for oil, we would describe as kind of 45 WTI, so although we’re pleased to see these higher prices, it’s just not something we can count on now. 

For the fourth quarter, Cenovus' cash from operations was $2.2 billion and its capital expenditures were $0.8 billion, for free cash flow of $1.3 billion. That's just for the quarter: annualized that would be $5.2 billion. The current FCF yield on the enterprise value is around 10% given last quarter's average price of crude oil.

Cenovus Reports Q3 2021 Earnings ($CVE)

[Previously, Long Reserve Life Oil: Cenovus Energy Inc. Cenovus, which acquired Husky last yearm is the third largest Canadian oil and natural gas producer and the second largest Canadian-based refiner and upgrader.]

Cenovus is listed on the NYSE (CVE, US$12.26) and the Toronto Stock Exchange (CVE.TO, CAD$15.26). (As you can see, a CAD$ is equal to 0.80 US$). When Cenovus acquired them, Husky shareholders received common Cenovus shares plus warrants. The warrants were issued in January 2021 and have five years until expiration (January 2026) with a strike price of CAD$6.54 (or US$5.23). With the CVE shares at $12.26, the intrinsic value of the warrant is $7.03 and they trade for $7.86.

Their Q3 results summary: "[Cenovus] generated third‐quarter cash from operating activities of $2.1 billion and adjusted funds flow of $2.3 billion. Free funds flow of $1.7 billion and strategic refinancing transactions resulted in a reduction in net debt to about $11 billion at the end of the third quarter. The company expects to achieve its interim net debt target of below $10 billion imminently as a result of continued strong cash generation at current commodity prices and receipt of proceeds from announced asset sales. This will pave the way for Cenovus to increase investor returns by commencing a share buyback program of up to 146.5 million of the company’s common shares, representing approximately 10% of its public float..."

The current market capitalization is CAD$30 billion and the net debt is CAD$15 billion for a total enterprise value of CAD $46 billion. (Or $24 billion market capitalization and $37 billion in USD.) The third quarter's CAD$1.7 billion of free cash flow, which annualizes to CAD$6.8 billion (US$5.4 billion) gives a FCF/EV yield of 15%. Thanks to the leverage and the low cost debt, Cenovus equity is trading at only about 4.4x cash available for distribution.

Also impressive is the level of FCF conversion; out of $2.3 billion CAD in adjusted funds flow, $1.7 billion is "free" (in excess of capital expenditure), which is 72%. Management's comments on further uses of cash flow in the Q3 conference call:

We finished the third quarter with net debt of about $11 billion, a reduction of $1.4 billion since the end of the second quarter. And today, we are very close to achieving our interim net debt target of below $10 billion, which takes me to our shareholder returns announcement. We have been clear that increase in shareholder returns would be our first priority, upon reaching our interim net debt target. Delivering on that commitment, our Board has approved doubling the dividend on our common shares effective for the fourth quarter dividend to $0.14 per share. In addition, the Board has approved filing of an NCIB application with the TSX for share buyback program of up to about 150 million common shares, which we expect to commence following the achievement of net debt below 10 billion. We will provide more context on how we think about capital allocation at our virtual investor day on December 8th. However, as we have said previously, when we are below 10 billion net debt, you should expect to see a more balanced approach to free funds flow application between further de-leveraging and shareholder returns. And at current commodity prices, we would expect to be able to execute our buyback plan in 2022, while achieving net debt under eight billion around mid-year. 

Canadian oil companies just seem unbelievably cheap. I do not understand why anyone is buying cryptocurrencies or the Robinhood bubble stocks when there are cheap pipelines, oil companies, tobacco companies, and banks. Capital markets have a good $5 trillion of worthless securities and coinz bouncing around. For that price, you could buy the entire energy industry, pipeline industry, tobacco industry, and community bank sector.