Cenovus Energy: Cash Flow Explodes Again, Market Focuses On Debt

Summary

• Market is focused on the C$12 billion in  debt.
• Already, the current portion of long term debt has been paid and about $2 billion more will be paid in the fourth quarter.
• Cash flow from operations is currently understated by an expanding working capital.
• "Adjusted Funds Flow" hovers near C$1 billion a quarter.  Longer term that will become the cash flow from operations.
• Increasing production and targeted synergies ensure some easy positive cash flow comparisons for the near future.

Mr. Market has been betting on a crash and burn that was never going to happen. Cenovus Energy (NYSE:CVE) management laid out the plan early before and during the acquisition. Mr. Market assumed the plan was a non-starter (an absolute failure from the start). But Mr. Market never reckoned with a company that had sold divisions before. So this management has been steadily carrying out the original plan. In return for giving up a little cash flow, the company is raking in billions. Mr. Market still does not seem to care. But as debt declines that should change.

Even more important, while the market has focused on the debt and debt ratios, cash flow has been unexpectedly strong. The potential is hidden behind an expanding working capital. But working capital expansion due to an acquisition does not go on forever.

(Canadian Dollars Unless Otherwise Stated)

Source: Cenovus Energy Management Discussion And Analysis Third Quarter 2017

As seen here, at least a quarter of the original amount has already been retired. The current portion of the bridge loan has now been retired. Management already has a lot more breathing room. Sales have been announced that should generate a little less than C$2 billion when closed in the fourth quarter. So maybe a billion or so will be left for management to cover with asset sales. Free cash flow as shown below could easily deal with that remaining amount. Unexpectedly the banks may be receptive to that solution.

(Canadian Dollars Unless Otherwise Stated)

Source: Cenovus Energy Management Discussion And Analysis Third Quarter 2017

As shown above (click on MD&A), the market may be spooked by the EBITDA ratio shown. Before the company always had a comfortable ratio. Now that ratio is beyond standard operating guidelines. But the Net Debt to Adjusted EBITDA should drop closer to 3 as both of the sales announced close in the fourth quarter.

But here is the big key though. Cash flow growth may give management more options despite the market focus on debt. Cash flow appears to be growing far faster than Mr. Market anticipated.

(Canadian Dollars Unless Otherwise Stated)

Source: Cenovus Energy Management Discussion And Analysis Third Quarter 2017

As you can see, management is having an unusual amount of success increasing the cash flow. Increasing commodity pricing has allowed the company margin to increase. But cash flow has increased above and beyond market anticipated amounts. Cost savings and increasing production have helped far more than anticipated.

The "Adjusted Funds Flow" shows the cash flow from operations before the change in certain account balances. A company like Cenovus that has just made a major acquisition will use a fair amount of cash to expand working capital. More production means more working capital activity. The first slide shows about $390 million in unfavorable account balance changes. That is a non-recurring event whose effect should be complete within a few months.

The "Adjusted Funds Flow" is the amount that the company will likely have available in the long run. Since the acquisition, this company has consistently managed to generate cash flow from operations before account balance changes of $1 billion. "Adjusted Funds Flow" is running more than double the year before. That is far more than Mr. Market ever anticipated. Dividing the debt into the "Adjusted Funds Flow" amount for the third quarter annualized gives a number of about 3.29. That is the kind of number that bankers are willing to work with.

The proceeds from the sales of announced properties make that number much more reasonable. The sales of discontinued operations will decrease cash flow somewhat. But expected production increases in the Deep Basin plus expansion of the main business should make up for any cash flow lost to sales of leases.

Management is in the position of using some cash flow to pay down debt. In fact free cash flow may well cover the remaining debt in a time period satisfactory to bankers. Banks do not usually like to have a ratio of debt to cash flow that is much larger than 3. This company is already meeting those guidelines. It is true that the company would not be as well positioned for a downturn. In the past the company had very conservative cash flow ratios just in case commodity prices took a dive. But there is plenty of time to use excess cash flow to pay debt or to grow production. Already, new production is coming online that will increase total production.

Source: Cenovus Energy June, 2017, Corporate Update

Another source of cash flow is the synergies goals listed above at the time of the acquisition. Management is unlikely to achieve all of this right away. But this is even more reason for management to slow down after the flurry of original sales. That remaining bridge loan can easily be converted if the cash flow is available to bring the ratios inline.

Currently, management can hedge (and in fact is increasing the hedging program) to protect profits. The remaining debt due can be handled by free cash flow if needed for a couple of years. The hedging program should provide the safety needed to ensure that happens.

So all this concern over the higher debt load and the worsening ratios appears overblown. Most likely management will continue to identify non-core assets to hasten the process of decreasing long term debt. Mr. Market could use a little more patience to allow this process to work. The constant selling pressure on the stock is probably an opportunity to get in on a good investment. So far Cenovus management has demonstrated some for tight fiscal controls on the operations. That is very likely to continue.

Long term, the "Adjust Funds Flow" will become the cash flow from operations. Working capital accounts do not change unfavorably forever. When the happens, Mr. Market will probably send the stock price higher suddenly. Cash flow is important, but so are the components of cash flow. In this case, the true potential of the company is still hidden. But as the effects of the acquisition wear off, more very pleasant earnings and cash flow comparisons are on the horizon. The stock is an easy double from current levels and it could increase more than that.

Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.

Analyst’s 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.

Comments

[me1999]

LP, great comments on your blog. Great stuff !!
UUP, I think, will rise.
If correct, be ready to click when UUP will change direction again.
That will happen in the 2nd Qt, or mid 2018.
UUP is the main valve.
It open & close the gate, in remote.

[Long Player]

Thank you very much for the comments.

[User 887790]

http://bit.ly/1SuOKZc
"From 2005 to 2016, Midwest refining capacity increased by 370,000 b/d to 3.9 million b/d. As of September 2017, Midwest refining capacity was 4.0 million b/d. The increased availability of crude oil in the Midwest and Canada has decreased the need for foreign imports moved through the Gulf Coast to supply expanding Midwest refineries..." I do like a good EIA report... expanding refining Capacity good to hear... "from 2005 to 2016, imports from Canada (the largest single supplier of crude oil to the United States) grew from 1.6 million b/d to 3.2 million b/d," Wow

Week before... "In 2016, the United States became a net exporter of gasoline for the first time on an annual basis with net gasoline exports of 56,000 barrels per day (b/d). Through September 2017 (the most recently available monthly data), the United States averaged net gasoline exports of 55,000 b/d. The shift toward net exports of gasoline on an annual basis has been a long-running trend." I wondered if the WTI-Brent price would cause USA to supply the world with discounted Gasoline??? Or will USA prices slowly rise since Big Oil wants World Prices??? Dunno... time will tell...

[heung]

LP, do you think there are still asset to be sold in the list within this year for cve ?!

[User 887790]

I noticed HSE Husky sold some Gas assets... guessing CVE will do something similar? I've loaded up ENF Enbridge Income Fund for Cdn dividends... the problem seems to be access to markets... and USA not getting World prices for Gas or Oil? I'm hoping this Brent-WTI differential goes away... clarify how much running room CVE has available. Otherwise 3.3 million bpd goes south but Enbridge or TRP Keystone are full-up... so we'll see... CVE has to roll out the Budget for 2018 some time soon. Drill, baby, drill...

[Long Player]

The market was so down on the debt situation that I think management will do what it can to alleviate that market concern.

At current prices, with the tax loss selling, I am rolling over an IRA as we speak and then I think I will back up the truck and load up.

[User 887790]

Have you looked at Enbridge Income Fund - ENF? or IPL Inter Pipeline? not sure about IRA tax situation... simple dividends at 7.8% ENF monthly. Potentially some Capital Gains? Access to markets is the problem; ENB, TRP, KML are fighting a hard, long struggle... At first I thought it was the Carbon Tax or the Border Tax... but maybe it comes down to Market Access; so many producers but so few means of Egress. Also hoping USA slows down on Rising Production... Oil prices are looking good; hoping it stays that way...

[WNB]

I'm shorting crude now to hedge my CVE position. CVE is giving it up like a stripper. Color me shocked.

[Long Player]

What gets me is they are showing major progress exactly as predicted...........and boom! the market really hates it. I bought some within the last day or so and will buy more I think. Sooner or later it either goes up or gets bought.

[heung]

Another asset sold ! But oil price is not intact .

[Long Player]

Now the bridge loan is gone. So the majority of the work is done and most of the company is still there.

[onec007]

Shocking! IEA reported a bearish tone forecast for the industry in 2018. What is it that they don't understand? Global growth is expected to hit 3% even if that's 0.50% overstated it would still average 2.5% higher. Asia including China and India which are much more important markets for the growth of oil demand than the US.

Again, these analysts and researchers just pull sh*t out of their asses and think because they have an MBA they know what they are experts at this topic. Shale production will increase next year, but NO where near the estimates that everyone seems to think that they will grow. Companies like EOG Resources, Pioneer are leaders of shale, but where is the profit?

They are now drilling a much higher-than-expected natural gas output ratio and they are spending so much on capital expenditures and costs are soaring for equipment and contractor work. Investors will want to see profits, dividend increase and/or stock buybacks over the continuous pumping of oil for little profit. In a boom/bust industry like oil, businesses fall hard. When investors give up waiting for profits, they flee in unison, and when that happens, the Shale Revolution will end. The only thing keeping shale producers afloat are investors and cheap credit. I am not suggesting that shale will disappear, but definitely weak players will be eliminated when they fail to be profitable.

Sorry, this isn't an Amazon model where profits don't matter eventually investors as well as creditors will want to see profits.

[xiang]

11.5 resistance.

[Stock-Research & Analysis]

let's see if the shorts or longs win with CVE over the next 6-12mths....long cve

[User 887790]

Commodity sales 22,816 23,842 28,281
Commodity costs 22,409 22,949 27,504
I dont have to go back very far... 2016 2015 2014 Annual report... Profit Profit Profit.. only $400M, $900M, $780M... ENB really dropped the ball on Commodity Trading... Q3. ENB talked about FX in Q2 since there's a lot of horse trading US / CDA... Overall ENB gets it right... This Transport cost at CVE is Quarter after Quarter... Ditto SU... (very low). But like I said maybe it's also related to Palliser, Suffield, Pelican... so it might drop substantially... but "commercial arrangements" must be a lot murkier than I thought.

ENB = Commodity sales of $22,816 million for the year ended December 31, 2016 (2015 - $23,842 million; 2014 - $28,281 million) were generated primarily through the Company’s energy services operations. Energy Services includes the contemporaneous purchase and sale of crude oil, natural gas and NGL to generate a margin, which is typically a small fraction of gross revenue. While sales revenues generated from these operations are impacted by commodity prices, net margins and earnings are relatively insensitive to commodity prices and reflect activity levels which are driven by differences in commodity prices between locations, grades and points in time, rather than on absolute prices. Any residual commodity margin risk is closely monitored and managed. Revenues from these operations depend on activity levels, which vary from year to year depending on market conditions and commodity prices.

[User 887790]

It's worse than I thought at CVE Cenovus... Sales at $4.386B (net of royalty $67M; Cdn$) now subtract Transportation and Blending $1.083B subtract Purchased Product $1.667B (which is Diluent to carry the Bitumen plus maybe the Nat.Gas to run SAGD)... 62.7% of cost is Pipelines and Diluent / N.Gas? $1B+$1.667B divided by Sales = $2.75B / $4.386B... wow...
Thankfully Operating Costs are low... $523M - Q3
(Gain) Loss on Risk Management $496M (disaster)
Depreciation, Depletion and Amortization $552M
General and Administrative $116M
Finance Costs $191M
I cant understand how the Oilsands makes any money... but ENB Enbridge seems to have a solid position trying to keep the Oil flowing. Someone must be making a fortune on the Diluent??? But breaking down Transport Costs $1.083B divided by 591,000 boe/d divided by 92 days works out to $20 per boe??? CVE says one barrel of Oil Sands Transportation and Blending costs $4.56... maybe after selling Palliser, Suffield, Pelican, Weyburn... the picture changes but there's a sizeable amount of money spent for transport? and I dont think it's Trucks and Railroads... Just a thought.

[stephenchan433]

Just sell then or if you don't own any shares why are you on this board? For those that actually have strong confidence in CVE I'm tired of reading people's comments about how poorly they are doing. New CEO is coming on board and the company has thus far been hitting their operational goals. I believe CVE will continue to show strength and is ridiculously undervalued and will be able to be a double bagger.

[DrT]

Mr. Chan, if you're so confident in your position, why you so insecure about hearing any contrary points of view?

[Long Player]

Oil sands has very low operating costs. The problem is the major investment to get it started. Also the product gets upgraded at company owned refineries. This is an Sunoil trick that does wonders to profits.

The diluent will most likely come from the western basin in the future one way or another. If they sell the light oil then its a tradeoff which makes the NGL and light oil very valuable to this company.

[WNB]

CVE gets pushed off a cliff and takes these pathetic baby steps back up. At this pace I doubt we will see 14 or 15 cdn share price. Crude will roll over and CVE will crash before that happens.

All of the technical analysis and swing traders are circling crude like vultures.

CVE has been a terrible investment and I'm praying that I can get out soon. If I buy anything it will be DWT.

[stephenchan433]

your credibility went down the tube when you said DWT. You do realize it is 3x the leverage ? Go ahead and buy highly speculative leverage ETFs I will stick with a company that is on queue to lower debt and hitting their operational strategies

[WNB]

Ok go with DNO then. speculating on the commodity itself might actually make some money. Unlike these garbage elevator down, stairs up Canadian oil companies.

crude is at a 2 year high and CVE can't manage 14 cdn...

[onec007]

If any of you have the chance read the below article dated back at the end of March. Probably the only analyst that actually correctly predicted the oil recovery. I always take analyst's analysis with a grain of salt, but this guy actually predicted it thus far correctly using common-sense i.e. huge draws and undevelopment of capital intensive projects.

http://cnb.cx/2iYgPyx

[User 887790]

https://bloom.bg/2zbJQL1
Plus there must be a huge problem in Venezuela... not sure what the problem is... just a few years ago didn't countries like Venezuela sell their Gasoline for 10 cents a gallon? I'm guessing the Demand is still there... but the price has suddenly gone UP? Although OPEC actually acting like a Cartel helps... just looking over the fence.

[pmember]

3 analyst raised their price target today. I Would be very happy for a $13 price.

[Dutchtender]

let me provide an antidote for what ails the SA consumer of information.
cve produced $592m CAD of operating cash flow last quarter.

out of this they spent $52m CAD to explore and evaluate
and $391m CAD on property plant and equipment.

this left ALMOST $150m CAD of free cash flow that CVE has available
to spend any way they see fit. But then you have to divide
that by a bit over 1.2b shares outstanding. And you have 12.5c of free cash flow per share.

Don't spend it all in one place.

[User 887790]

Dont forget the big Nickle in dividends... Anyhow did you see ATH Athabasca Oil's Q3 numbers? ATH spent a mountain of money $74 million in a quarter Drilling Wells.... vs Funds flow from operations $34M or Cash flow from operating activities $49M... I was hoping the market would celebrate their efforts but Flat as Pancake or even Selling off? ATH has Statoil as a major shareholder at 100 million shares (20%)... Montney : Recent IP30s of 1,206 boe/d (66% liquids) exceed upsized type curve expectation o Currently drilling a 6 well pad that is intended to maintain 2018 Light Oil volumes in excess of 10,000 boe/d... no joy in Mudville; even with Murphy Oil as a partner?

[Dutchtender]

i don't think murphy wants the oil sands. the scenario I see is ATH selling their liquids rich gas business to MUR or MUR just totally getting out of Canada completely. MUR does not want oil sands imo. these stocks are not going to get out of the mud until we get well OVER $55wti and stay there. oh and nat gas has to get over $3mcf too. the best thing stuck o&g investors can do to make their stocks go up is pray. :)

[User 887790]

About the only good news I heard is CVE is testing Solvent Assist as a Pilot project... might roll it out in 2019 depending on field results. Otherwise everyone's dialing back the spending... "rationalizing"... to reduce the big pile of debt. Looks like CVE would be happy with $50 Oil... since it's really struggling to break $55 WTI in 2017... maybe China takes another bite? Or India? Demand for Oil should slipping and sliding this time of year... according to CVE's hedging program.

[Stock-Research & Analysis]

As a major holder in CVE, COP cannot dump all their 208m shares all at the same time according to regs/rules in the US. So I believe this is likely to be a slow wind down of shares over time. Remember CVE sold shares to COP over C$17.3s PER share, so COP would be selling at a loss if they start unwinding now. Overall COP ownership is not a big issue and is likely to be well placed in block trading especially if oil price stays at this level.

[Lasvegasfreddie]

I don't see the shares reaching the trading market. These shares will either be sold to funds, another company who wants interest in CVE or a proactive investor like Icahn.

[Ruben123]

Looking for strong compoanies that are not hedged. any suggestions? it seems these companies will book massive hedging loss in coming quarters.

[Long Player]

Remember, its non-cash and what they have really done is locked in the price. .....and profits...

Look at Ring Energy and Laredo Petroleum, I have articles on Both so let me know what you think

[shazo]

Thanks Long Player for this piece. Just read your LPI piece- looks fantastic- but I cannot figure out the drop in price Was the street looking for $.14 eps? With what looks like a serious multi-year breakout in WTI last week as it took out a two year high(and it's closing in on $56 as I write), this week should have tons of action in these names. Sanchez is another intriguing situation with a massive short position that I own, but not in size. The capital structure on SN is much more complicated than I originally thought- but it's still a potential moon shot. Love CVE here

[Long Player]

LPI loves to test and experiment. It may be driving the market nuts. They actually had a fifth rig solely for testing that they just released. Then they announced they want to review the test results against performance for awhile.

The proof of this is in the extremely low costs and good cash flow as well as a return to profitability. But as you said Mr. Market may have wanted more. So management diddling over testing may not be popular, but it sure appears to help cash flow.
The other thing is management wants to outspend cash flow for a year or two and the market appears to hate debt.

then again, management just paid off the bank line and called some notes with the proceeds of the pipeline sale. Plus the profits of that sale appear to be about $2 a share for the fourth quarter.

I really don't see anything wrong. Just market impatience.

Just like CVE. Management doing exactly what they said and the market is hammering the stock every successful step of the way.
Gotta love it.

[Lasvegasfreddie]

Unfortunately it is 208 million. I don't think they want to unload it now. My guess when they sell it will not be on the open market but to funds or another company that wants 15% of Cenovus.

[Long Player]

I think they will wait for CVE to straighten out the debt. They are not anxious to take a loss on the shares right now.

[heung]

Any concern on the 2 million shares hold by cop; the restriction of sales lift on 14 Nov

[Lasvegasfreddie]

The comment on hedging is idiotic. They are not 100% hedged more like 50% or less. As oil goes up in price their upside is capped if oil goes down their downside is capped. I am not big fan of hedging, but in cenovous case they need it to protect against downside spikes.

[stephenchan433]

Agreed! plus they probably needed to get bankers off their backs because of debt levels plus with all the sentiments towards lower for longer it was prudent to have predictable cash flow.

[User 887790]

Only sold 50% of CVE... If my math is right... 290,000 boe/d for 6 months in 2018??? That's like 76% of the Oilsands (380,000) Deep Basin (120,000)... There's also six months of 75,000 July - Dec 2018 $49.32WTI... I think this 25,000 put option helps them barely... This Costless Collar is a better approach to hedging... like $50-$60 Brent? Who knows if it goes much higher in the next year...

Weyburn is about 25,000 boe/d... maybe they'll get $1.5 Billion? $60,000 per flowing barrel... offset some of the PAIN? Good luck.

Brent Fixed Price 60,000 bbls/d January – June 2018 US$53.34/bbl (37)
WTI Fixed Price 150,000 bbls/d January – June 2018 US$48.91/bbl (108)
WTI Fixed Price 75,000 bbls/d July – December 2018 US$49.32/bbl (39)
Brent Put Options 25,000 bbls/d January – June 2018 US$53.00/bbl 16
Brent Collars 80,000 bbls/d January – June 2018 US$49.54 –
US$59.86/bbl (14)

[Long Player]

You have to remember that the profit got locked in because of the debt. It was a sure thing and probably not worth the risk of lower pricing. Now if they keep the hedging program up it will even out. If not, then they are in for a period of lower realized pricing.
That is it really.

[Stock-Research & Analysis]

I guess Buzz6rd is short CVE. It is a hedging program to protect on the downside as CVE works through the asset divestiture program. There could be losses in a rising price environment but for now it looks mostly unrealised. Accelerated hedge is mostly short-term up to mid 2018...I bet on CVE long-term.

[twfry]

And not everything is hedged. A loss of $300M in hedges net-net results in an overall gain of $300M extra cash flow if they were 50% hedged for example. Plus they can now hedge at higher prices to lock in more future cash flow. It's all a positive, how anyone can spin it as a loss is beyond me.

A rising oil price environment will result in 1) some amount of hedge loses today, 2) an even larger increase in EDITDAX that outweighs the hedges, 3) significantly improved cash flows on their massive future inventory (which is what really matters on a go forward basis). Anyone short must be scared at this point. Why anyone would be short at these valuation with today's supply/demand balance is beyond logic.

[User 887790]

Page 28 http://bit.ly/2z89jFk
Here's an eye opener... Since Sept 30... Oil has appreciated yet CVE has already Booked 313 million Hedging Loss??? Just seeing this... had me pushing the SELL button. Only 50%... I've also got my doubts about COP's game plan 200 Million Shares of CVE (16.7% outstanding shares). The Biggest problem "FIXED" price for Brent at $50 when Oil is at $60 Brent??? Notice how the Collars have very little Loss... It's almost like CVE expect $40 WTI? Shooting themselves in the Foot??? As for spending CVE is curtailling any Spending at Foster Creek... $350 million already spent... $850M to complete but the re-start date is yet to be announced... 3 years to complete... I think these Hedging losses must be more like a Billion Dollar Loss... considering the price of Crude. Just a thought...

As at September 30, 2017 Notional Volumes Terms Average Price Fair Value
Crude Oil Contracts
Fixed Price Contracts
Brent Fixed Price 108,000 bbls/d July – December 2017 US$51.68/bbl (61)
Brent Fixed Price 36,000 bbls/d August – December 2017 US$49.90/bbl (28)
Brent Fixed Price 60,000 bbls/d January – June 2018 US$53.34/bbl (37)
WTI Fixed Price 150,000 bbls/d January – June 2018 US$48.91/bbl (108)
WTI Fixed Price 75,000 bbls/d July – December 2018 US$49.32/bbl (39)
Brent-WTI Differential 50,000 bbls/d July – December 2017 US$(1.88)/bbl (16)
Brent Put Options 55,000 bbls/d July – December 2017 US$53.00/bbl 4
Brent Put Options 25,000 bbls/d January – June 2018 US$53.00/bbl 16
Brent Collars 80,000 bbls/d January – June 2018 US$49.54 –
US$59.86/bbl (14)
WTI Collars 50,000 bbls/d July – December 2017 US$44.84 –
US$56.47/bbl (2)
WTI Collars 10,000 bbls/d January – June 2018 US$45.30 –
US$62.77/bbl 2
WCS Differential 16,000 bbls/d January – March 2018 US$(13.11)/bbl 1
WCS Differential 15,000 bbls/d April – June 2018 US$(14.05)/bbl -
Other Financial Positions (1) (16)
Crude Oil Fair Value Position (298)
Natural Gas Contracts
Fixed Price Contracts
NYMEX Fixed Price 30 mmcf/d July – December 2017 US$3.16/Mcf -
NYMEX Fixed Price 99 mmcf/d August – December 2017 US$3.11/Mcf -
NYMEX Fixed Price 69 mmcf/d September – December 2017 US$3.09/Mcf -
NYMEX Fixed Price 2 mmcf/d October – December 2017 US$3.25/Mcf -
Interest Rate Swaps (15)
Total Fair Value (313)

[DrT]

Ferguson was infamous for his bad hedging when he was CFO at Encana. In one! quarter he managed to lose a quarter of a billion dollars in bad hedging.

[stephenchan433]

Good sell and get off this board!