Sunday, July 31, 2022

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).

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