Cenovus Energy: Easier Than Taking Candy From A Baby

About: Cenovus Energy, Inc. (CVE)
by: Long Player

Mr. Market pounded this stock into the ground because of the debt load.

The market really ignored the approximate quadruple of the cash flow from the first to the second quarter.

This stock should appreciate as the property sales underway are announced. Even a sales price disappointment should be seen as progress by the market.

Aggressive growth plans are underway even as the debt reduction progresses. This company is nowhere near a debt spiral like other troubled companies.

The preliminary response to the first sales announcement is a guide to the future responses as the deleveraging progresses. Banks are very likely to work with the company if one of the deals collapses.

The bank vault is wide open and no one cares if you take the money. In fact, that money is just spilling out everywhere. Sometimes, Mr. Market just throws money at you and you just cannot believe it is that easy. But it is that easy and easier when the market reaches an irrational bottom.

First, Cenovus Energy (CVE) negotiated a very good deal, but Mr. Market focused solely on the debt and dumped the stock. One would have thought that the company management never did its homework to undo the debt. The market acted as though the pathway to fixing the balance sheet was impossible. The company would sink under a load of debt despite the strategy management laid out. Plus this management was very specific too. Mr. Market should have realized that management not only had a plan but they have a backup plan in case the first plan came up short.

Source: Cenovus Energy September 5, 2017, Press Release

Management had previously stated that there would be an announcement of the sales progress of the first two properties during the third quarter. Shown above is the first announcement right on schedule. The market reacted as though this announcement would never happen. The stock price response was overwhelmingly positive as shown below. This demonstrates how the market grossly overreacted in the negative direction.

Source: Seeking Alpha Website September 15, 2017, After Market Close

As shown above, word probably leaked out a little bit early. However, it is clear the market has responded positively to the news. So if management just sticks to the original schedule and announces the property sales within the time periods established, an investor could profit handsomely. The market punished this stock for loading up with a bridge loan. One would have thought that paying the bridge loan was mission impossible. Or maybe the market thought that this management was out of its league. The stock price dropped 50%. So just getting back to where the stock started is going to be an easy double. The market was concerned with the payment schedule.

There was also the fear that the company would be forced to sell at distressed pricing. However, this management has sold projects before. There is far more experience here at buying and selling than the average investor may notice at first. So this management more likely had contingency plans if problems developed. The market, however, punished the stock as though the bridge loan payback schedule was onerous enough to threaten the existence of the company.

Source: Cenovus Energy September 5, 2017, Press Release

The rest of the announcement makes it clear that nothing could be further from the truth. Once this first deal closes, then the next amounts to pay down the bridge loan are not due until 2018. But a deal collapse would most likely be met with lender cooperation because management is doing exactly what they stated they would do. Lenders can tell when significant progress is being made as opposed to a management with its head in the sand. This management stated that a few billion in properties were going to be sold and that is exactly what is happening. In fact, Mr. Market should have bet that management discussed specific property sales with the lenders beforehand in addition to the backup plans.

A quick review of the annual reports on the company website shows some past portfolio adjustments. The difference this time was the pace of the portfolio adjustment. Instead of just one or two deals a year, the particular goal was several billion dollar sales in a short period of time. But management stated the desire to conduct an auction and sell in a weak price environment. So a disaster was unlikely given the past history. However, the market thought otherwise.

An investor is very likely to achieve a rather generous return from the current stock price simply by holding the stock through the auction process. The next few months should prove very rewarding unless commodity prices crash and stay low. This stock could provide a very low risk but high reward return. The stock price shown above was just a preliminary movement. There will probably be a little reversal of the price. More announcements will continue to lift the price.

The second even larger return could come from some unexpected operational performance by management. This management absolutely crushed second-quarter expectations.

Source: Cenovus Energy Barclays Presentation, September, 2017

Despite some very easily measured goals, along with a management that very clearly and publicly grades itself, the market had severe doubts about the long-term plan and the deal. Institution after institution was in the paper stating that the debt was too high even though management stated the debt would come down. Operational achievements were not even considered. This deal was just plain bad as far as Mr. Market was concerned. The company was left for dead. But the nice part about being left for dead is that the only way left to go is appreciation.

As shown above, the plan is underway with a growth part. Management stated that the expansion of some of the unconventional production was self-funding. Now management is talking about adding rigs to increase that production. Much of the significant production areas are listed above, along with a fairly aggressive growth schedule that paces the debt reduction. But the market is in no mood for realistic goals. This market demands proof. So as these goals unfold, this stock will probably increase substantially.

Management probably will not crush every quarter. But it does not have to for expectations to increase. Right now the stock price is still at the "debt will kill the company" point. But last quarter showed enough operational progress that cash flow could soon handle the bridge debt. That will give management far more flexibility than the market bargained for. The market should instead expect that ratios will be back to historical levels within a year.

Disappointing property sales, if that happens, will be met with additional property sales until the debt is manageable. The chances of a debt spiral such as Chesapeake Energy (CHK) is now experiencing is slim. Chesapeake appears unable to sell enough properties to significantly reduce the debt burden per BOE. That could spell doom for the company. Cash flow has been miniscule for Chesapeake Energy this fiscal year. Sales of properties will reduce production. Despite upbeat management pronouncements, it is hard to see where production will outgrow the debt requirements.

Cenovus has no such problems. The first sale will generate about $1 billion. Cash flow may decrease, but this management has plans to replace that cash flow with increasing production from core properties. Cash flow in the second quarter beat expectations of any reasonable kind. Cenovus management could fall $1 billion short of the sales proceeds goal and still not be close to a debt spiral. Yet the market does not appear to be able to tell the difference. This management even separates core production from non-core production. Mr. Market has doubts despite the very visible goals and very specific report cards. The negativity could not be worse.

Cash flow from operating activities roughly QUADRUPLED from the first quarter. That first quarter was not that poor a quarter either. No troubled company such as Chesapeake Energy or Denbury Resources (DNR) accomplished anything near that. Management for the first time is now free of partner ConocoPhillips (COP). So investors should expect a lot more agility and flexibility to go with the demonstrated cost control. The future of this stock is a whole lot brighter than the market is willing to admit. That is a big advantage for investors.

Plus, this company has considerable refining capacity to upgrade products and provide some industry downside protection. The company may not be quite as protected as the giants like Exxon Mobil (XOM) or even Suncor (SU), but that diversification is a considerable advantage over many competitors. Low costs have been a company signature for some time. So this company will eventually be recognized for its accomplishments. In the meantime, the downside risk is pretty minimal.

Disclaimer: I am not an investment advisor, and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CVE over 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.