Debt-Reduction and Low-Cost Synergies to Drive Business Performance: MEG Energy Corp. (TSX: MEG) focuses on sustainable in situ thermal oil production.  The company transports and sells Access Western Blend ("AWB" or "blend") to refiners in North America and internationally.

Outlook: The company recently announced a capital reduction program in light of the COVID-19 crisis, which is likely to enable it to survive through the near-term challenges. MEG reduced its 2020 capital budget by 20% to CAD 200 million from CAD 250 million. MEG expects its FY20 production to be in the range of 93,000 – 95,000 bbls/d, down from the previous guidance of 94,000 – 97,000 bbls/d.

FY19 Financial Highlights: For the period ended December 31, 2020, MEG reported total revenues of CAD 3,931 million, up 44% over FY18, thanks to the significant jump in revenues from the sales of third-party purchased products. Higher average realization from bitumen of CAD 53.21 per barrel as compared to CAD 36.69 per barrel also contributed the top-line growth. MEG reported a net loss of CAD 62 million, as compared to a net loss of CAD 119 million in FY18. Improved bottom-line performance was on account of 18% lower general and administrative expense coupled with a higher cash operating netback, while an unrealized loss on commodity risk management remained a drag. The company has reduced its debt by ~CAD 630 million till date, including CAD 132 million in FY20. Adjusted funds flow in 2019 was CAD 726 million, up from CAD 180 million in 2018. The stellar growth in adjusted funds flow came on the back of higher cash operating netback of CAD 32.15 per barrel in 2019 compared to CAD 17.61 per barrel in 2018.

FY19 Income Statement Highlights (Source: Company Reports)

Valuation Methodology (Illustrative): P/CF Based Valuation Approach 

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

Stock Recommendation: The stock of MEG is trading at CAD 2.75 with a market capitalization of CAD 823.75 million. The stock corrected ~65%. At current price, the stock is quoting at the lower band of its 52-weeks trading range of CAD 8.07 and CAD 1.13. The stock closed above its 20-days simple moving average (SMA) of CAD 1.91. The performance of the company is correlated with the international crude oil prices, which led to a recent recovery of ~30.95% during the last five trading session, outperforming the index by ~21.07%. We have valued the stock using Price/CF-based relative valuation methodology. For this, we have considered peers like Husky Energy (TSX: HSE), Tourmaline Oil Corp (TSX: TOU), and Cenovus Energy (TSX: CVE) etc., and arrived at a target price which implies a lower double-digit upside (in % terms).  MEG has enough liquidity to weather the COVID-19 crisis and has no debt maturities in the near-term, which is encouraging. The stock looks undervalued given the sharp decline in the recent past. MEG stock is likely to recover sharply as economic conditions improve and oil prices normalize. However, given the recent price volatility in MEG’s stock prices, we recommend a ‘Speculative Buy’ on the stock at the closing market price of CAD 2.75 as on April 9, 2020.

MEG One-Year Daily Price Chart (Source: Thomson Reuters)

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