Seeking Alpha
Research analyst, growth, large-cap, long-term horizon
Profile| Send Message|
( followers)  

Summary

  • CNQ has outperformed most of its peers YTD.
  • The company is expected to grow production at a strong 9% CAGR for the next 5 years.
  • CNQ does not only offer strong double-digits liquids production growth but the company’s solid long-life asset base also provides sufficient downside protection.

The Calgary based Canadian Natural Resources (NYSE:CNQ), the country's largest independent oil and gas producer, has outperformed most of its pure major oily exploration and production [E&P] peers and domestic integrated oil sands peers YTD. The company similar to its other Canadian peers has been has been steadily climbing and the stock price has almost double in the last 12 months. CNQ is up 25% YTD.

(click to enlarge)

Source: Google Finance

Strong Upside With Downside Protection

A number of factors have contributed to this outperformance. Horizon, which had previously been plagued by problems, is delivering improved and more reliable performance. The recent tightening of Canadian heavy oil price differentials has also contributed to the recent outperformance. The company is expected to grow production at a strong 9% CAGR for the next 5 years. Thermal, heavy oil, and Horizon volumes are the main drivers of this production growth.

Canadian Natural Resources [CNRL] does not only offer strong double-digits liquids production growth but the company's solid long-life asset base also provides sufficient downside protection. The company's strong oil-oriented, long reserve life portfolio offers significant expansion potential. The Calgary based company is also the largest natural gas producer in Canada and provides a near free option on any upside to natural gas prices.

Execution Risk Dissipating

Canadian Natural Resources is in the middle of an expansive capital program, which will ultimately result in a long-life production mix that is less volatile than market current expects. Execution risk around several key projects is dissipating and the capital requirements for the company's various expansion initiatives are coming more into focus. This improved execution and narrowing heavy oil differentials will improve confidence in the CNQ's growth and robust cash generating profile and a return to its premium valuation. CNQ boasts a large and balance portfolio of assets and this balanced portfolio plays an important role in the company's future growth, free cash flow and value upside.

Plans to Monetize Royalty Portfolio by Year-End

As previously indicated, CNQ intends to monetize its royalty properties by the end of 2014. CNRL continues to integrate and review its royalty portfolio and plans to decide on the best option to maximize value for shareholders by year-end. The Calgary based CNQ has previously indicated these lands generate pre-tax cash flow of C$140-150 million.

CNRL has stated that it plans to monetize this asset via either an outright sale or a spin-out as a separate entity similar to what Encana (NYSE:ECA) did via its Prairie Sky IPO. Given the company's strong balance sheet and cash generating power, it is less likely that CNQ would just perform an outright sale of the properties as opposed to a possible spin-out or IPO. With cash flows of $140-150 million, Citi's analyst Robert Morris values this entity at as much as $2.5 billion or more.

Strong Results

CNQ reported 2Q14 operating EPS of $1.04, topping Wall Street estimates of $0.96 by 8%. The beat was largely due to better than expected Horizon oil sands and primary heavy oil production, partly offset by lower-than-expected international oil volumes. The company's total production of 817.5 MBOE/d increased 19% sequentially.

Due to temporary steam capacity restrictions at Kirby South and the delay of a low-pressure steam flood at Primrose East, the company slightly lowered its full-year guidance to 789-819 MBOE/d (from 792-836 MBOE/d). At Kirby South, incremental steaming is being brought back in stages and full steam capacity should be restored by November. These small operational issues are temporary and I believe the successful ramp up of Kirby will be key in obtaining market credit for CNQ's thermal assets. There is potential upside to the scope of CNQ's thermal asset portfolio with more new developments revealed like the 12 MBbl/d Lindbergh project during CNQ's Open House in June. At Primrose East, the bitumen seepage cleanup is complete but the implementation of a low-pressure steam flood awaits the approval of an application submitted recently.

Valuation

CNQ is also trading at attractive valuation. Despite of reduced maintenance capital needs, CNQ is trading at a discount. An increasing share of volumes are coming from long-lived stable assets and pushing maintenance capital needs down. I expect CNQ to return to its premium valuation as investors become more comfortable with CNQ's execution on Horizon and the thermal operations.

CNQ is trading at forward price/earnings of 12.1, compared to 29.8 of Crescent Point Energy (NYSE:CPG), 54.1 of Talisman Energy (NYSE:TLM), and 12.5 of Canadian Oil Sands (COS). Similarly CNQ has EV/EBITDA of 6.7, compared to 8.1 of COS, 6.6 of TLM, and 10.0 of CPG. The company also offers a healthy dividend yield of 2%.

Conclusion

CNQ has had a strong 2014 so far. The company outperformed its peers by a significant margin. CNQ is up 25% YTD, in comparison CPG is only up 6.3%, COS 15% while both TLM and Husky Energy (HSE) are down YTD. Despite of this outperformance the company is still trading at a discount. I believe the company will return to its premium valuation as investors become more comfortable with CNQ's execution on Horizon and the thermal operations. The company does not only offer significant future upside with double-digit expected production growth but also enough downside protection with its solid long-life asset base. The broad upside potential also comes with minimum political risk as majority of production comes from either Canada or UK.

Source: Canadian Natural Resources: Upside Potential With Downside Protection