Company Overview: Cenovus Energy Inc is a Canada-based integrated oil and natural gas company. The Company's operations, include oil sands projects in northern Alberta and oil production in Alberta and British Columbia. The Company is owner of two projects that are producing oil, Christina Lake and Foster Creek. The oil sands projects use a drilling method called steam-assisted gravity drainage or SAGD for short. The SAGD process uses natural gas to heat water into steam, which helps The Company to extract the oil out of the oil sands. The company also holds interest in two United States refineries, Wood River located in Roxana Illinois and Borger located in Borger Texas.

Stock Details 

Cenovus Energy Inc.

Cenovus Rides on Higher Oil Sand Production Volumes: Cenovus Energy Inc. (TO: CVE) is Calgary-based integrated energy company in Canada, primarily involved in producing, developing and marketing oil, natural gas and natural gas liquids (NGLs). As of Dec 31, 2019, CVE had a land base of approximately 5.3 million net acres. Based on working interest production, the estimated proved reserves life index was around 31 years at the end of 31 December 2019. Cenovus Energy has four operating and reportable segments namely, Oil Sands, Deep Basin, Refining and Marketing, and Corporate and Eliminations.

The Oil Sands segment of CVE is involved in producing & developing bitumen situated in northeast Alberta. The bitumen assets are located in Christina Lake, Foster Creek, and Narrows Lake. In FY19, the company’s Oil Sands segment reported revenues of CAD 10.8 Billion and accounted for approximately ~51% of FY19 total revenues. The company’s Deep Basin segment consists of approximately 2.8 million net acres of land. These lands are located in Kaybob-Edson, Elmworth-Wapiti, and Clearwater functioning areas. The segment recorded sales of CAD 691 million in FY19 and represented around 3% of CVE total FY19 revenues. CVE’s Refining and Marketing segment consist of selling & transporting crude oil, natural gas and NGLs along with joint ownership of two refineries in the U.S. The segment recorded revenues of CAD 10.5 billion in FY19, which accounted for ~49% of FY19 total revenues. CVE’s Corporate and Eliminations segment consists mainly of derivative financial instruments related to unrealized gains and losses, along with other CVE’s general & research costs. The segment contributed a negative 3% to the revenue.

Coming to the past four-years performance over the period covering FY16 to FY19, the company witnessed a top-line CAGR of ~11.5%. Cash flow from continuing operating activities increased at a CAGR of ~7.7% over the same period. The company’s net debt reduced by 22% on an annual basis. The group also finished the construction on its Christina Lake phase G oil sands expansion. The company also predicts to generate around CAD 11 billion cumulative free funds flow over the next 5 years, as depicted in the figure below.

Free Fund Flow 5-Year Plan (Source: Company Reports) 

4QFY19 Financial Highlights for the Period Ended 31 December 2019: During the fourth quarter, the company reported total revenue from continuing operations of CAD 4,838 million, signifying a rise of 6.4% from CAD 4,545 million reported in the year-ago period. The increase was primarily on the back of higher oil sand production volumes. Earnings per share in 4QFY19 was 9 cents per share as compared to a loss of CAD1.10 per share reported in the year-ago period. Total production from continuing operations came in at 467,448 BOE/d in 4QFY19, up 8% year over year.

Production Summary (Source: Company Reports)

Oil Sands Segment: During the quarter, gross revenues from the Oil Sands unit came in at CAD 2,659 million, an increase from CAD 1,380 million in the year-ago quarter. Higher production volumes of oil sands were the key drivers. In the December quarter, oil sand volume production stood at 374,132 bbls/d, up 15% on a year over year basis, due to reduced curtailment levels. Furthermore, the segment’s operating margin stood at CAD 674 million against the loss of CAD 178 million reported in the year-ago period, owing to higher transportation & blending expenses.

Deep Basin Segment: The company reported gross revenues from the Deep Basin unit of CAD 190 million, which was flat on a year over year basis. The company is taking necessary measures to optimize its Deep Basin operating model to lower costs and improve operational efficiency and maximize shareholder’s value. In the December quarter, Deep basin production stood at 26,197 bbls/d, down 7% year over year. Furthermore, the segment’s operating margin for the quarter stood at CAD 81 million, as compared to CAD 62 million in the year-ago quarter, due to lower operating expenses.

Refining and Marketing segment: Gross revenues from this segment for the fourth quarter came in at of CAD 2,555 million, as compared to CAD 3,048 million reported in the year-ago period. Moreover, the segment’s operating margin stood at CAD109 million, down from CAD 251 million, owing to the rise in Canadian heavy crude price along with higher operating expenses. The Wood River refinery was re-rated in January 2020 to indicate better processing capacity of 346,000 gross bbls/d, an increase of 13,000 bbls/d from 2019.

Segmental highlights (Source: Company Reports)

Total Costs in 4QFY19: Transportation and blending expenses in the reported quarter stood at CAD 1,416 million as compared to CAD 1,269 million in the year-ago quarter. Nevertheless, expenses for purchased products declined to CAD 2,059 million from CAD 2,555 million reported in the year-ago period.  The company reduced upstream operating expenses on a year over year basis, on the back of increasing focus on cost leadership.

Balance Sheet, Capital Expenditures & Reserves: The company incurred total capital expenditure of CAD 317 million in the fourth quarter as compared CAD 276 million in the year-ago period. The company generated CAD 361 million in free funds flow, against a fund outflow of CAD 312 million in the year-ago period. As of December 31, 2019, the group’s cash and cash equivalents stood at CAD 186 million, and total long-term debt stood at CAD 6,699 million. The company reduced its net debt by a further CAD 289 million to CAD 6.5 billion at the end of the period. Its net debt-to-capitalization ratio was ~25%, with net debt to adjusted EBITDA stood at 1.6x at the end of FY19. The group mentioned that it has total proved reserves of 5.1 billion barrels of oil equivalent. 

Cash Flow Details & Dividend Details: The company generated cash inflow from operating activities of CAD 740 million, as compared to cash inflow of CAD 485 million reported in the year-ago period. It is to be mentioned that CVE increased its quarterly dividend by 25%. For the twelve months ended December 31, 2019, the company paid dividends of CAD 260 million. For the first quarter of 2020, the group announced a dividend of CAD 0.0625 per share, which is payable on March 31, 2020.

Shareholder’s Return & Dividend (Source: Company Reports) 

Recent Update:

On January 30, 2020, the company unveiled a key initiative targeted to address the lack of enough housing that is forcing many families to live in overcrowded and hazardous circumstances. For this purpose, the company is giving CAD 10 million every year for a period of 5 years to construct new homes in six First Nations and Métis communities, which is situated near to its oil sands operations in northern Alberta.

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 50.17% of the total shareholding. ConocoPhillips Company is the entity holding maximum shares in the company at 16.93%. Fidelity Management & Research Company is the second-largest shareholder, with a holding of 6.84%.

Top Ten Shareholders (Source: Thomson Reuters)

Key Metrics: In FY19, the company had a gross margin of 58.2%, up from the prior corresponding period margin of 58%. The margin has seen an improvement over the last five years period covering FY15 – FY19, with FY15 gross margin at 36%. EBITDA margin also improved over the year with FY19 margin at 19.3%. Net Margin of the company was stood at 10.9%, depicting an improvement on the prior corresponding period margin of -14%. The company has debt-to-equity ratio of 0.45x, lower than the FY18 ratio of 0.52x, indicating a sound financial position.

Key Metrics (Source: Thomson Reuters)

Outlook: The company is taking necessary measures to boost shareholder’s return via cost management, capital control measures and ongoing consistent operations. CVE anticipates creating ~CAD11 billion cumulative free funds flow for the coming five years, on the back of positive crude-by-rail program, upstream assets, and collaborative possession in two high-performing U.S. refineries. This in turn will aid CVE to further strengthen its balance sheet in FY20.

For FY20, Cenovus revealed its objective of expanding capital spending to CAD 1.3- CAD 1.5 billion from the FY19 level of CAD 1.2 billion. The increase was on the back of production curtailments announced by regulators in Alberta. Most of the spending (~70%) is expected to go towards maintaining production levels at Foster Creek and Christina Lake oil sands businesses.

The company expects total production for FY20 to be in the range of 472-496 MBoe/d, up from FY19 level of ~467 MBoe per day. The company’s crude-by-rail program along with allowances by local government’s Special Production is expected to lead to higher production. It is to be mentioned that the rise in output will be supported by its oil sands operations that are expected to be in the range of 390-410 MBbls/d in FY20. The company expects Deep Basin production to be 82 – 86 MBoe/d in FY20.

For FY20, the company expects capital investment in Refining and Marketing assets to be in the range of CAD 285-CAD 330 million as compared to FY19 actual level of CAD 280 million. Further, the company is planning to invest CAD 705- CAD 820 million in the Oil Sands business in FY20, higher than the 2019 actual level of CAD 706 million.

 FY20 Outlook (Source: Company Reports)

Key Valuation Metrics (Source: Thomson Reuters) 

Valuation Methodology: 

Method 1: Price to Cash Flow Multiple Approach

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Method 2: EV/EBITDA Multiple Approach

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: As on 27 February 2020, the stock has a market cap of ~CAD 12.4 billion with a P/E multiple of ~5.9x and an annual dividend yield of ~2.5x. The company has recorded revenue CAGR of 11.5% over the last four years. We have valued the stock using two relative valuation methods, i.e., P/CF multiple and EV/EBITDA multiple, and for the said purpose, we have considered peers like Suncor Energy Inc (TO: SU), Imperial Oil Ltd (TO: IMO) and Canadian Natural Resources Ltd (TO: CNQ). Therefore, we have arrived at a target price with an upside of lower double-digit (in percentage terms). Considering the above factors, we give a “Buy” recommendation on the stock at the closing market price of CAD 10.12 per share, down ~4.1% on 27 February 2020.

1-Year daily price chart (as on February 27, 2020). Source: Thomson Reuters.

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