Husky Energy Has A Lot Of Future Options

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About: Husky Energy Inc. (HUSKF), Includes: BTE, MEGEF, PGHEF, RRENF
by: Long Player
Summary

Husky is fully integrated like its larger Canadian competitors.

Profitability of that integration is far more reliable and reasonable as a result.

Distressed competitors appearing now may be bargain acquisitions in the near future.

Currently, cash flow exceeds net debt.

Breakevens are low for a thermal/heavy oil producer and declining.

Husky Energy (OTCPK:HUSKF) usually flies "under the radar," leaving the limelight to its more famous competitors like Suncor (SU). However, this fully integrated company is very profitable and every bit as well run as its more readily identifiable competitors. The relatively low debt ratios and relatively reliable profitability give this growing company a lot of options as the un-diversified heavy oil industry continues to suffer from inadequate profitability. But do not expect a lot of acquisition activity during an oil price upturn unless the activity is at a bargain-basement price that includes conservative downturn assumptions.

One example of the growth discipline was the announcement that the offer for MEG Energy (OTCPK:MEGEF) was allowed to expire.

Source: Seeking Alpha Website April 4, 2019

The result of the expiration of that offer is shown above. MEG Energy stock promptly collapsed about 50%. This made a very deep hole for current management to dig itself out of in the process of justifying the continued company independence. More importantly, Husky may come back with a reduced offer for the company in the near future at any sign of MEG Energy financial distress.

MEG Energy is a highly leveraged company with weak finances. The result is that the management is in a poor position to demand a premium to the current price. Plus an unfavorable turn of events for any reason at all could send this company into "strategic review" resulting in an even more unfavorable outcome for shareholders.

Another currently distressed company is Pengrowth Energy (OTCQX:PGHEF). This company's management just launched a "strategic review." For common shareholders, strategic reviews are usually very bad news that end in unfavorable outcomes as well as nonexistent common shareholder returns. But for a financially strong company like Husky Energy, this type of news is extremely favorable. All Husky has to do is wait for the right moment to bid on these distressed assets at bargain pricing. The business's "golden rule" is that the cash holder makes the rules.

Therefore, while the current market evaluates Husky Energy on current growth prospects as delivered by operating activities, the market may be about to deliver some distressed properties at bargain pricing. Husky Energy could be about to enter a rapid growth phase that the market does not anticipate. In the past management has often offered a combination of shares and debt that were accretive to shareholders. Yet the offer did not highly leverage the company so as to endanger the future of the newly combined company.

A batch or basket of these fairly financially strong Canadian integrated heavy oil producers (including Husky of course) probably will outperform market expectations as the weaker players slowly head towards reorganization.

Investors should note the difference between the companies mentioned above and Baytex Energy (BTE). The market apparently expects trouble from Baytex Energy as the shares have declined. But Baytex Energy acquired Raging River Exploration (OTC:RRENF). That enabled the company to pick up some light oil cash flow without adding a lot of debt. The cash flow acquired in the acquisition is viewed as far more stable than the heavy oil cash flow. Hence Baytex has the ability to persuade lenders that the combined company has a robust future despite the fourth-quarter oil price collapse. Furthermore, Baytex has time to pay down bank debt to prove its point.

Both MEG Energy and Pengrowth will be hard-pressed to make a similar financial case. Pengrowth, in particular, has not shown a profit in several years and waited until lenders pressed for asset sales before paring debt down to current levels. Banking relations in both cases could easily be shredded or at least at wary levels.

Husky's Financials

In the meantime, Husky Energy can watch all this and more from the sidelines while displaying its bank account for all those concerned to see. This is a very old game. Simply stated, management touts its cash assets and then does not use them for the acquisition. If the acquired company balks in any way, shape or form, then management simply decides when to wait for the next bargain (all the while showing everyone how financially strong it is).

(Canadian Dollars Unless Otherwise Stated)

Source: Husky Energy February 2019, Corporate Presentation

Management constantly harps about cash flow exceeding the net debt figure. This Alberta, Canadian producer usually keeps about C$2 billion on hand "just in case." That provides management with considerable flexibility when shopping for acquisitions. The opportunity advantage far exceeds the interest cost at a time like this.

But that cash balance and low net debt figure also lower the downside risk of the stock. Should the stock price decline too much, this very healthy company could become an acquisition target of its much larger competitors.

In the meantime, the wholly owned midstream operations and the refinery (as well as upgrading capability) provide a cushion when the frequently profitless thermal and heavy oil business does not provide cash flow sufficiently. Those owned refineries are reporting a cheap source of feed-stock from that low priced oil to balance out the losses on the oil production side.

(Canadian Dollars Unless Otherwise Stated)

Source: Husky Energy February 2019, Corporate Presentation

The result of all of that integration is that this company survives when the WTI price approaches $35 per barrel. The thermal business has high upfront costs and therefore cash flows at remarkably low pricing even if the overall thermal business is not making money.

This company also has a growing offshore business to offset any current hostile North American (especially Canadian) conditions. Cash flow would need to drop to about C$500 million before there were any repayment worries at the current balance of net debt. Oil pricing that low would be unlikely to remain at that low price for long.

In the meantime, Husky will probably generate a lot of cash flow for the current price. Management can be counted on to wait for a bargain. Husky has a long history of growing. However, that growth can be lumpy as acquisitions tend to add more immediate growth than the steady completion of internally-generated projects.

Source: Seeking Alpha Website April 6, 2019

The market value of the stock shown above is remarkably cheap for a company that generated approximately C$4 billion of cash flow from operations in fiscal year 2018. Currently, rising oil prices could cause a favorable revision of the market view of this company. The ownership of several valuable integrating divisions limits the company's exposure to Canadian headwinds. Most likely this company will grow cash flow this year which makes this stock remarkably cheap.

Any cyclical downturn will find this management on the prowl for bargains. This company is a beneficiary of downturns even though earnings and the stock may decline some. Typically, this company emerges from cyclical downturns larger and in at least as good a financial condition as before the downturn. Management has become adept at integrating smaller distressed competitors.

The stock price does not anticipate any of the favorable outcomes. Instead, the market is waiting for this company to fall victim to another Canadian crisis. But the ownership of several integrating divisions makes that outcome highly unlikely. The rising offshore production provides still more diversification from an unfavorable financial outcome.

This is still an oil and gas company. Plus Husky is a thermal and heavy oil producer as well. However, this management has done a lot to benefit from the low pricing these products have received in the recent past. Those benefits have offset a lot of pain that the competition suffers.

Once the market realizes this, a return to a far more normal six to eight times cash flow would be a realistic expectation. There is no disaster awaiting this company in the future. There is, however, plenty of decent possible outcomes that the market has not priced into the stock.

Disclosure: I am/we are long BTE. 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.

Additional disclosure: 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.