Cenovus Energy; A Go Or A No Go?

| About: Cenovus Energy, (CVE)

Summary

Cenovus Energy was free cash flow negative in Q4 (and the entire year) 2015.

The company took the only right decision by cutting its dividend (again).

With a little bit of luck, Cenovus could be cash flow neutral in 2016, but I wouldn't bet on it.

Despite a healthy working capital position of in excess of $3B, Cenovus could be planning to raise more cash, indicating it wants to protect its future.

Introduction

The oil price remains quite volatile but by the time a recovery starts, I want to make sure I have placed my chips on the right oil and gas company. Not only should my potential investment in any oil and gas company have the possibility to survive the current glut for at least a few more years, I would also like to have some leverage instead of a debt-ridden company. There's one relatively large company I haven't discussed yet, and that's Cenovus Energy (NYSE:CVE).

CVE Chart

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The financial results are in, and Q4 looks okayish at first sight

In the fourth quarter of 2015, the company produced approximately 200,000 barrels of oil per day of which approximately 70% as produced at the company's oil sands project. On top of that, Cenovus also produced 424 MMcf/day of gas. The production rate slipped a bit in the final quarter as the full-year average production rates are approximately 207,000 barrels/day and 441 MMcf/day of gas, and I think it's noteworthy (but not unexpected) to see the majority of the reduction in the oil production being caused by the company's conventional sources.

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Source: financial statements

Cenovus still is a major player on the oil and gas scene and despite the horribly low oil and gas prices, the company was still able to report a total revenue of C$2.9B ($2.1B) (undoubtedly also helped by the weaker Canadian Dollar which was very helpful to offset the lower sales prices). Unfortunately the company's pre-tax income was negative and even after a C$241M ($175M) tax benefit, Cenovus was still unable to avoid a net loss of C$641M ($464M) as the depletion and depreciation costs were relatively high in the fourth quarter. The full-year results are still looking pretty good on the income statement as the full-year revenue of C$13.1B ($9.5B) resulted in a net income of C$618M ($448M), which gives you a real impression of how bad the final quarter of the year was.

Of course, an income statement of an oil company rarely tells you the full story, and I would strongly encourage you to also have a look at Cenovus' cash flow statements (in fact, you should double-check the cash flow statements of all oil and gas companies you're thinking about investing in).

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Source: financial statements

The future looks slightly brighter when you indeed use the cash flow statements, as Cenovus (fortunately) was still able to generate a positive operating cash flow. Okay, yes, the C$322M ($233M) in operating cash flow isn't sufficient to cover the C$428M in capital expenditures in Q4, but at least the cash outflow remains relatively limited, and this will prove to be a very important factor in the future. Yes, the company was free cash flow negative, but the situation most definitely isn't disastrous at all.

The revised guidance for 2016 includes another harsh dividend cut

As Cenovus was free cash flow negative, it was quite obvious 'something' had to be done and the company tried to tackle this problem in its plans for 2016. One of the most drastic (but necessary) measures was to cut the dividend. Indeed, even though Cenovus wasn't generating a positive free cash flow, the company was still paying a dividend.

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Source: company presentation

Okay, that dividend had already been slashed from almost C$0.27/quarter ($0.20) to just C$0.16 ($0.11) per quarter (reducing the outflow by C$92M ($67M) per quarter and almost C$400M ($290M) on an annual basis), but this clearly wasn't sufficient. The board of directors has decided to cut the dividend by an additional 69% to a symbolic C$0.05 ($0.035) per quarter, but as this still causes a net outflow of C$42M ($30M) per quarter, even this reduced dividend isn't really sustainable either.

Does this mean the company will cancel the dividend? Well, technically it should definitely consider doing so as I don't think Cenovus will be profitable this year and I also don't think shareholders should be hoping for a free cash flow positive situation. Cenovus has been guiding for a full-year production rate of 205,000 barrels of oil (midpoint) as well as 385 MMcf/day of gas. That's very nice but despite cutting the capital expenditures by almost 30%, Cenovus still expects it will have to spend C$1.2B-1.3B ($905M) on capital expenditures and that's still a lot of money (C$300M ($217M) per quarter).

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Source: company presentation

Yes, the company's production cost is low, but despite this, the capital expenditures will eat away the entire cash flow, even if the oil price would move back up to $35/barrel. For instance, the average capex per barrel of oil produced at the oil sands operation will be approximately C$14 ($10), and that's quite a lot. Don't get me wrong, it's doable, but it will be a tricky year, especially as the refining and transportation operations will also require a capex of in excess of half a billion Canadian Dollars.

Investment thesis

So, no, I don't believe Cenovus will be free cash flow positive this year unless the oil price rallies towards $40-45-50 by the end of this year. However, I do believe the company will be able to keep its cash outflow limited, and thanks to a working capital position of in excess of C$4.5B ($3.2B), there's no immediate danger Cenovus will go out of business, especially as its hedge book will also unlock some additional value.

In fact, breaking even might even be possible this year, and that's why Cenovus is still trading at a double-digit share price. This company does have a chance thanks to its extremely robust working capital position and its intention to raise more cash. I think this company has a very good management team working around the clock to protect its shareholders. Better be safe than sorry.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.