Friday, November 5, 2021

Canadian Natural Resources Limited ($CNQ)

[Canadian Natural Resources is our third and final Canadian oil company in the basket with Cenovus and Suncor.]

Canadian Natural Resources (CNRL) (NYSE: CNQ) is a bit different than Cenovus and Suncor. For one thing, they don't have any refining or retail businesses, although they do upgrade the bitumen produced by their oil sands. Also, while they are an oil sands producer, both by mining and in situ extraction, they also have assets in the UK North Sea and Africa offshore (Côte d'Ivoire), plus conventional oil and gas production in Canada, including much more natural gas production than the other two companies. 

CNRL's production was 1.24 million BOEs per day in Q3, which is as much as Cenovus and Suncor combined. The production of all three in our Canadian oil basket (~2.5mm boe/d) is more than half of Canada's oil production and about as much as Kuwait produces.

The market capitalization of CNRL is US$50 billion, and $14 billion of net debt makes the enterprise value US$64 billion. Note that the three Canadian oil companies have a combined market capitalization of US$113 billion and give you 2.5 million barrels of oil equivalent of daily production. Meanwhile, Uber and Doordash, which are both unprofitable, have a combined market capitalization of $150 billion.

During the first three quarters of 2021, CNRL has reduced debt by $5.4 billion (CAD) and spent $2.4 billion on dividends and share repurchases. In just the third quarter, the company earned $2.2 billion (CAD) net and generated $2.7 billion of free cash flow. If you annualize the most recent quarter, you are looking at $7 billion (US) of net income or $8.6 billion (US) of cash flow. So the company is trading at a P/E of 7x based on Q3 oil and gas prices, which were lower on average than they are today.

Some highlights from the Q3 conference call:

Our long life low decline assets support a sustainable, growing and predictable dividend. This was evident through the period of challenging commodity prices in 2020, where we increased and maintained our dividend, then further increased it in March of 2021, marking the 21st year of dividend increases.

Subsequent to the quarter end, the Board of Directors has approved a 25% increase to our quarterly dividend to $0.5875 per share payable on January 5, 2022. This represents a $0.47 per share annualized increase. This clearly demonstrates the confidence that the Board of Directors have in the sustainability of our business model, the strength of our balance sheet and the company's effective and efficient operations, supported by a robust, long-life, low-decline asset base and associated low maintenance capital requirements.

With this increase, 2022 will mark the 22nd consecutive year of dividend increases for the company. And this 25% increase from our previous quarterly dividend is in excess of our historical dividend compound annual growth rate of 20% over the last 22 years. Last quarter, we discussed that effective July 1, 2021, our free cash flow allocation policy authorized management to increase returns to shareholders through accelerated share repurchases under the company's normal course issuer bid by targeting the repurchase of approximately 1% of shares outstanding per quarter.

This policy further states that once the company reaches an absolute debt level of $15 billion, currently targeted to occur in Q4 2021, 50% of free cash flow will be targeted to share repurchases with the remaining 50% of free cash flow allocated to further strengthen our balance sheet. For this policy, the company repurchased approximately 12 million shares in the quarter.

CNRL puts an awesome metric in their investor presentations: "proved plus probable reserves before royalties (BOE) per common share". For 2020 year-end, it was 13.5 BOE, up from 8.3 BOE at the end of 2016. (This number can actually grow over times if accretive share repurchases and rising oil prices outpace depletion of the resource). So for $43.50 per share you are getting 13.5 BOE of 2P resource! Note that the BOE metric of course includes natural gas at a 6:1 BTU ratio with oil. If you look strictly at 1P (proved) crude oil reserves, it is an enterprise value of $6 per barrel, and that is ignoring natural gas as well as probable reserves.

Remember what it is that we like about royalty trusts and long reserve life, slow decline Canadian oil companies. They both avoid the principal-agent problem that afflicts other types of oil and gas producers with small amounts of reserves that need to be replaced often in order for managements to keep their jobs. Those companies have a poor track record of creating long term value for shareholders because management's incentives are bad. They need to buy assets to keep their companies from liquidating (and losing their jobs), but they only have the money to buy assets at the top of the cycle when properties are expensive. The companies that fracked for shale over the past decade managed to transfer almost all of their investors capital (both equity and debt!) to sellers of land and service providers.

1 comment:

CP said...

Using US$100 per barrel in 2023, we estimate that the average of 23 Canadian energy stocks we model is trading at a free cash flow yield of 42 per cent, and, therefore, could privatize with just 2.4 years of free cash flow. Contrast this with oil companies having an average of 15 years of drilling inventory, and energy ignorance is allowing investors to acquire more than a decade of free cash flow streams for literally nothing.

How do we measure potential further upside? Using a targeted free cash flow yield of 10 per cent to 15 per cent on an enterprise level, we estimate the average Canadian energy stock still has about 129 per cent left to run.

The biggest risk to energy investors who have enjoyed the gains of recent years is selling too early because they didn’t quantify what upside still potentially exists. Dare to dream. The path forward will no doubt remain volatile, yet we believe the confluence of growing demand and challenged supply growth means we are in a multi-year bull market for oil that will last for at least five to six years.