Company Profile

Canadian Natural Resources Ltd (TSX: CNQ) is a Calgary, Canada-based oil & gas upstream company. CNQ's operational interest lies in the exploration and production of the oil and gases, with a balanced and diversified portfolio of assets, primarily located in Canada, with international exposure in Great Britain and Africa.  The company's portfolio includes light and medium oil, heavy oil, bitumen, synthetic oil, natural gas liquids, and natural gas. The company's market-capitalization of CAD 27.35 billion ranks it among the large-caps stocks listed and traded on the Toronto Stock Exchange. 

Investment Thesis

• CNQ is a cash cow: CNQ has a proven track record of quarterly dividend payment since 2001. Over the past four-year to December 31st, 2019, the company has registered a CAGR growth of 12% in its dividend payment. Further, amid challenging times, which has emerged in the wake of COVID-19 led uncertainties, the board of the company has announced a dividend of CAD 0.425/share for Q1FY20, which was approximately 13% higher as compared to the dividend declared in Q4FY19. Moreover, the company is offering a very attractive dividend yield of 7.5%, which is about 14 times of Canada’s 10 Year Benchmark Bond Yield of 0.54% and 1.8 times of the S&P/TSX 60 average dividend yield of 4.1%. Also, amid low interest rate environment, when the central banks across the world are pouring money into the system, it is impossible for investors to find a high yield income opportunities, which in turn is likely to bring high yielding quality dividend stocks in focus. CNQ is one such company with a proven track record and sufficient liquidity to cover the future dividend payment.

Source: Company Report 

• Robust Balance Sheet and Liquidity Position: CNQ has a strong financial position with significant liquidity, which is likely to allow it to sustain amid the short-term turmoil in the oil and gas prices. At the end of Q1FY20, the company’s liquidity position stood at CAD 5.0 billion, which was approximately CAD 116 million higher against the preceding quarter of FY19. The cash and cash equivalent stood at CAD 1.1 billion along with the committed bank credit facilities, which seems to be sufficient enough to settle its debt obligations. 

• Investment-grade credit profile: The strong balance sheet and the ability of the company to generate positive free cash flow is the secrete sauce behind the investment-grade credit profile of CNQ. On March 20, 2020, Moody's reaffirmed the CNQ's long-term and short-term investment-grade credit profile of Baa2 and P-2, respectively with a stable outlook.  Standard and Poo rated the group with a long-term investment-grade credit rating of BBB and A-2 for the short-term investment-grade credit rating with a sustainable outlook. 

• Key Competitive Advantages of CNQ: The company has low maintenance or sustaining capital with flexible capital allocation to maximize the shareholder's value. Further, the company is targeting an operating cash flow of CAD 700 million from natural gas production over the next twelve months at AECO pricing of $2.50/GJ. Also, CNQ's free cash flow breakeven oil price including current dividend stood at US$ 30 – 31 WTI/BBL and operating breakeven including debt services stood at US$ 25 – 26 WTI/BBL.     

• Higher margin of Safety: Return on Equity (ROE) is defined as “Net Profit/ Total Equity”. A company uses equity capital to invest in assets, which in turn generate cash flow and earnings. Therefore, for the owner to create value for himself, the return on equity (ROE) must be greater than the Weighted Average Cost of Equity (WACE). Here, in the case of CNQ, the company’s FY19 ROE stood at 16.18%, whereas Weighted Average Cost of Equity for the same period stood at 12.5%, which implies that the spread of approximately 370 bps between ROE and WACE. Therefore, this access ROE is the measure of excess return to an investor in the company. And it also reflects the management’s efficiency. 

Financial Highlights: Q1FY20

On May 07th, 2020, the company reported its financial results for the period ended on March 31st, 2020. During Q1FY20, CNQ reported a record quarterly production of 1,179 MBOE/d, maximum allowable volumes under Alberta curtailment program. The company’s operating cost improved, with E&P liquids’ first quarter operating costs stood at CAD 13.71/bbl, approximately 15% down from the Q1FY19. During the Q1FY20, the company reported a net loss of CAD 1,282 million as compared to a net profit of CAD 961 million reported in the same quarter of the previous financial year, driven by a steep plunge in commodity prices in the wake of COVID-19 pandemic. However, on an adjusted basis, the company reported an adjusted net loss from operation of CAD 295 million in the same period. Further, the company has no asset impairment in the first quarter of 2020, despite a record low oil prices at the end of the quarter.

Disciplined Budgeting: During the period, the company has reduced its original capital program of 2020 by CAD 1.4 billion to CAD 2.7 billion. The group spend CAD 838 million as capital expenditure against the erstwhile budget of CAD 1.3 billion.

Balance Sheet remains firm: The company's liquidity position remained strong at CAD 5 billion at the end of the Q1FY20, with CAD 1.1 billion in cash and cash equivalents. Further, the credit rating agencies reconfirmed the group's investment-grade credit profile in Q1FY20 with a stable outlook. Debt to book capitalization remains under manageable territory at 39.4%, with coverage ratio at the end of Q1FY20 stood at 2.6x.

Returns to Shareholder: Despite a highly tumultuous quarter led by the steep plunge in oil prices, the company maintained its quarterly dividend at 0.425/share, which was about 13% higher as compared to the previous quarterly dividend per share. Also, the company reported an increase in dividend per share for the 20 consecutive years. However, the share buyback plan has been ceased on March 11th, 2020.

Determination of Reserves- FY19

For the financial year ended on December 31st, 2019, the reserve committee of the company has carried out an independent due diligence procedure with the IQREs to the CNQ's reserves. The company's performance for FY19 was decent on the finding and development costs front.

Finding, Development and Acquisition (FD&A) costs excluding consideration for Future Development costs (FDC) stood at CAD 4.52/BOE for proved reserves and CAD 5.34/BOE for proved plus probable reserves. During the year proved reserves leapt up by 11% to 10.93 billion BOE with the addition and revision of reserves of 1.501 billion BOE. CNQ's proved plus probable reserves improved by 6% to 14.252 billion BOE with addition and revision of 1.271 billion BOE.

Proved reserves additions and reserves replaced CNQ’s 2019 production by 374% and proved plus probable reserves and addition replaced the company’s 2019 production by 317%, respectively. CNQ’s proved BOE reserves expected life valued for 27.8 years and proved plus probable BOE reserves expected life is 36 years.

Further, the company stated that the net present value of future net revenues, pre-tax, with a discounted rate of 10% increased by 1% to CAD 107.6billion for proved reserves, however, for proved plus probable reserve, NPV slipped by 2% to CAD 127.8 billion.

Stock Performance

1-year price chart (as on May 15th, 2020). Source: Refinitiv (Thomson Reuters)

Shares of CNQ has recorded strong recovery from the recent free-fall took place in March 2020, on account of the steep plunge in the oil prices in the international market. In a month-over period, CNQ stocks are featuring a price return of 27% and significantly outperformed the benchmark by ~ 25% and its peer group by ~ 6% in the same time. Further, at the last five trading sessions, its shares bagged approximately 7% and outperformed the benchmark index by ~ 10%. This reflects a strong reversal trend in the stock.

Over the past 52-week, CNQ shares registered a peak of CAD 42.57 as on January 03rd, 2020, and tested a bottom of CAD 9.80 as on March 18^th, 2020, which reflects steep volatility occurred in the stock since the beginning of the year. However, at the last traded price of CAD 23.88, the stocks have bounced backed approximately 136% from those lows, which reflects a strong recovery in the CNQ's shares because of strong fundamentals that the group posses within the oil & gas upstream space. 

Top-10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 35.42% of the total shareholding. Capital Research Global Investors and Fidelity Investments Canada holds the maximum interests in the company at 11.4% and 4.31%, respectively.

Source: Thomson Reuters 

Valuation Methodology (Illustrative): EV/EBITDA

 *Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters). NTM – Next Twelve Months. 

Stock Recommendation

Recovery in oil demand and proposed oil production cut will benefit CNQ positively:  The outbreak of COVID-19 from the mainland of China to approximately 210 countries across the world has hit the oil exploration and producers significantly. A lockdown announced by majority of countries globally along with a restriction on travel, trade and other economic activities weigh on the oil demand and led to a crash in the oil prices globally.  However, after months of lockdown and restriction, economies across the world opening gradually. China (a major consumer of oil and oil derivative) has resumed to full functionality. Other major economies like the U.S, European countries and India are considering ways to slowly reopen their economies. These developments are likely to bring back the oil demand, and positive price actions could be seen in the near-term. Also, a record production cut announced by OPEC and its allies would further bring stability in the oil prices.

Strong fundamentals built upon Competitive Advantages:  CNQ has a robust balance sheet with easily manageable debt exposure, which reduces the balance sheet risks of the company as compared to many of its peers. Further, the group has a track record of free cash flow generation, which strengthen the liquidity position of the group. Also, the company’s strong ROE, which is significantly higher than the weighted average cost of equity, implies that the company is in the hands of efficient management and generating an excess return for the shareholders. 

A dividend income play amid falling interest rates environment: The company is offering a dividend yield of 7.5%, which looks attractive amid the low interest rate environment. This is a single strong financial measure for an income investor standpoint. 

Further, the recent reversal trend its shares has recorded on the daily and weekly price chart indicates that the stock is carrying higher potential to move up further towards its long-term support level of 200-day SMA. Therefore, based on the above rationale and valuation done using EV/EBITDA methodology, we have given a “Buy” recommendation at the current price of CAD 23.88 (as on May 15, 2020), with a lower double-digit potential upside (in % term), based on the NTM EV/EBITDA (12.2x) on the FY20E EBITDA. We have considered Suncor Energy Inc (TSX: SU), Husky Energy Inc (TSX: HSE), and Cenovus Energy Inc (TSX: CVE) etc. as peer group.

Disclaimer

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