Can An Elephant Hide In Canada? Upside For Canadian Natural Resources Limited

Aug.12.14 | About: Canadian Natural (CNQ)

Summary

Canadian Natural Resources Limited (CNQ) continues to grow prudently within its heavy oil specialization.

Second quarter 2014 results show solid increases from first quarter 2014 and from second quarter 2013.

Given its prospects, the company's valuation compares favorably with its North American competitors.

Canadian Natural Resources Limited pays a dividend.

With the Keystone Pipeline out of the news and U.S. investors focused on domestic plays like the Bakken, Marcellus, Permian and Eagle Ford, it is easy to miss the Canadian elephants to the north.

Canadian Natural Resources Limited (NYSE:CNQ) is a Calgary-headquartered company with a current market capitalization of $46 billion. It trades on the Toronto Stock Exchange and the New York Stock Exchange under the symbol CNQ and is governed by securities regulations of Canada and the United States. Amounts quoted are denominated in United States dollars unless otherwise indicated by C$.

Canadian Natural develops, produces and sells oil, natural gas liquids and natural gas. In terms of oil, it offers everything from light crude to heavy bitumen and synthetic crude oil.

In addition to its activities in Western Canada, Canadian Natural has operations in the North Sea, the Côte d'Ivoire, Gabon and South Africa. It owns three crude oil pipeline systems and half of an 84-megagwatt cogeneration plant.

Investors with an appetite for detail are referred to its just-released 61-page 2nd quarter 2014 report . A summary can be found on the company's website homepage. A link to a taped rebroadcast of its August 7, 2014 conference call is available on the company's website until August 14.

What makes detailed analysis of Canadian Natural Resources Limited time-consuming are the several different qualities and prices of the crude oils and natural gas liquids it produces, the corresponding location and market differentials and the size and reach of the company's other operations from overseas to natural gas to pipelines.

Map

The map below shows Canadian Natural Resources' operations in Canada.

Click to enlarge

Oil Supply Background

The ISIS takeover of some Kurdish oil facilities has persuaded majors to temporarily leave Iraq. In addition to concerns about Iraq and Libya, other large producing areas with output issues are Kashagan, the Arctic and the Niger Delta. The Niger Delta suffers both from the Ebola outbreak and pullouts by technologically-sophisticated majors due to longstanding corruption issues. Some Arctic leaseholders have allowed their leases to lapse due to the difficulty, expense and short drilling season.

Production and Cash Flow

In the second quarter of 2014, Canadian Natural Resources Limited produced 1.6 billion cubic feet a day of natural gas and 545,000 barrels per day of liquids, a number that includes all flavors of crude oil and natural gas liquids. Both numbers represent substantial increases from the first quarter of 2014 (39% more natural gas, 11% more liquids) and from the year-ago second quarter comparison for 2013 (45% more natural gas, 25% more liquids).

Its cash flow from operations was $C2.63 billion in the second quarter of 2014, compared with $C2.15 billion for the first quarter of 2014 and C$1.67 billion for the second quarter of 2013.

Potential investors parsing these numbers further are reminded that natural gas prices will differ from United States futures prices by transport and market differentials. Most critically, physical oil prices will differ from United States oil futures prices in several ways: a) condensate price vs. oil price: the two have completely different markets; b) the wide variety/quality differentials of the oils Canadian Natural produces; c) transport differentials; d) location/market differentials; and e) a cross-currency difference between U.S. and Canadian dollars. The current exchange rate is 0.91 U.S. dollars per 1.0 Canadian dollar.

Canadian Competition

Similarly-sized competitors include Suncor (NYSE:SU) with a $57 billion market capitalization, Imperial Oil (NYSEMKT:IMO) at $42 billion and Encana (NYSE:ECA) at $16 billion.

Operational Issues

The Primrose and Wolf Lake Oil Sands area experienced bitumen seepage at four locations in 2013. Causes for the seepage have been identified and mitigation is underway.

Although construction of the Keystone Pipeline XL would add upside to Canadian Natural, it is not expected to occur soon. Nonetheless, in a March Seeking Alpha article Bret Jensen suggested that even without Keystone, Canadian Natural has significant strengths.

Ironically, since refiners added units at great capital expense to process more heavy, sour crude like that produced by Canadian Natural, it is in demand. Canadian heavy crude competes with new United States' production. However, the competition is somewhat indirect since the vast new supply of light, sweet U.S. crude requires different processing.

Among several expansions identified by Canadian Natural in its second quarter conference call is a 45,000 BPD expansion at the Horizon project. For the first six months of 2014, Canadian Natural drilled 425 oil wells and 38 gas wells.

Canadian Natural has been lauded by Motley Fool for controlling its costs.

Oil Prices

On August 8, 2014, the closing NYMEX futures prices for light sweet crude oil in September was $97.65. The Western Canadian Select oil price in the second quarter of 2014 was about 19% less than the benchmark WTI price. Canadian Natural employs hedges on the differential between West Texas Intermediate and Western Canadian Select crude oils.

Gas Prices and Canadian Supply/Demand

Canada produces 13.9 billion cubic feet of natural gas a day, ranking it fifth in the world. The top two natural gas producing countries are the US and Russia; the US produces about 85 billion cubic feet a day and Russia only slightly less. The Montney formation in Alberta and British Columbia is estimated to contain 250-350 trillion cubic feet of natural gas. This is similar to the Marcellus in Pennsylvania, which is estimated to contain 225-520 TCF.

Canada consumes less natural gas than it produces, about 8 billion cubic feet per day.

Note that the natural gas futures price is $3.96/million British Thermal Units, but that price is at Henry Hub, Louisiana. Prices for natural gas further north-from Pennsylvania, for example-tend to be lower due to the enormous increase in its production overwhelming the takeaway, or pipeline transport, capacity. This issue can be seen in price: the benchmark Alberta natural gas price is about a dollar less than the U.S. Henry Hub price.

As of this month, sixteen liquefied natural gas export projects were proposed or underway in British Columbia. The Kitimat plant, backed by Chevron Canada and Apache Canada, is closest to completion.

Ownership

Institutions hold about 63% of the company. The five largest are Royal Bank of Canada (4.9%), FMR (Fidelity) (3.8%), Davis Selected Advisors (2.9%), Bank of Montreal (2.5%) and First Eagle Investment Management, LLC (2.3%).

Stock Highlights

IAE Research earlier this year identified Canadian Resources for its good dividends.

The company is covered by a total of 31 analysts. Its mean analyst recommendation on Yahoo!Finance is 1.6, in which 1.0 is a strong buy and 5.0 is a strong sell. The average comprises 5 strong buys, 5 buys and 1 hold. Although not all the firms are listed, they include Global Hunter Securities, Stifel Nicolaus, Barclays, Deutsche Bank, UBS, Canaccord Adams, Credit Suisse and Collins Stewart. A different group of NASDAQ analysts gives Canadian Natural similarly good ratings of 7 strong buys, 2 buys and 1 hold.

The projected growth in earnings per share is from $2.25 to an estimate $3.91. Thus, its current price-to-earnings ratio is 19 and its forward price-to-earnings ratio is 10.6. Its dividend is $0.83/share or about 2% of the stock price. As of the end of 2013, its ratio of liabilities to assets was 50%.

Canadian Natural Resources Limited is not undiscovered. With a high United States stock market and an August 8, 2014 closing price of $42.02/share, the stock is at 90% of the high end of its 365-day range and at 81% of its one-year target.

Canadian Natural Resources Limited is a large-capitalization stock that, even without the construction of the Keystone XL Pipeline, has solid growth prospects. At its current price and projected future earnings per share, its forward price-to-earnings ratio is more moderate than some of its West Texas competitors.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.