Cenovus Energy Cash Flow Will Jump Again

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

The C$1 billion per quarter is likely to more than persist except during the annual turnaround and maintenance during Spring Breakup.

Cash flow has been growing in lumps ever since the acquisition from ConocoPhillips.

Canadian challenges will be overcome.

This company has its own railcar loading asset and some refining capacity to overcome low thermal prices.

Low operating costs (that keep declining) and declining capital costs further aid the company's profitability.

Cash flow reported by Cenovus Energy (CVE) has consistently exceeded market expectations because the market was focused on the challenges of the Canadian oil and gas industry. Never mind that this company overcame those challenges surprisingly often. The market focused instead on problems that appear to have lasted a quarter. In the meantime, cash flow grows and the stock price drops. One of those will win and I am betting on the cash flow.

Dire predictions rarely happen. The market expected those large WCS discounts to go on forever. Instead, the usually volatile oil market prices have now moved to the point where WCS quotes are unusually strong. There are still many heavy oil and thermal oil producers in the Canadian market doghouse. Those producers that have integrated or have some diversification to steady the often spotty heavy oil cash flow may be worth consideration.

The market concern for the long term cash flow of heavy oil and thermal oil producers is warranted. Since the big oil crash a few years back, the heavy oil and thermal oil business has rarely cash flowed consistently. Most of the time there was no cash flow regardless of accounting profits posted. An occasional bullish period failed to significantly alter the long-term results since that oil price crash.

But those (heavy and therm oil) companies with upgrading capacity, refineries or even light oil production have a source of cash flow during the extended lean times. Both upgrading capacity and refining capacity take advantage of the lower input costs from those large WCS discounts to report wide margins. Some lighter oil production provides a higher margin product with some cash flow even during periods of low WTI pricing. Nearly any solution is better than just producing heavy oil or thermal oil. The heavy oil industry trend towards diversification (like Baytex Energy (BTE)) appears to demonstrate that the heavy oil producers cannot survive alone.

Cenovus Energy has some refining capacity. The latest acquisition has provided a foray into natural gas. This will take time to develop as the seller, ConocoPhillips (COP) clearly ignored the marketing of the gas and potential takeaway issues. More importantly, Cenovus Energy has been inspecting the gas properties and thermal properties for hidden jewels and it may have found some conventional oil in the process. Oil is far more valuable than gas.

Conventional oil production would be a wonderful addition to the Cenovus production capabilities (especially conventional light or lighter oil). Therefore, the value of the properties acquired from ConocoPhillips (as well as properties owned solely by the company) will take an upward re-evaluation as the oil discovery is delineated. There will probably be more discoveries as the acquisition inspection process continues (though right now that is pure conjecture). The continuing technology improvements will probably also add value to all the properties in the future.

Financial Progress For The First Quarter

Finances appear to finally project a decent cash flow not encumbered by hedges that get in the way or other challenges that worry the market. Though the market has little faith in long-term strong pricing (at present). Management appears to be using the time to strengthen the balance sheet, lower costs, and prepare for a growth future regardless of industry conditions.

(Canadian Dollars Unless Otherwise Stated)

Source: Cenovus Energy First Quarter 2019, Earnings Press Release

The market wanted a strong first quarter and the company delivered that anticipated positive earnings comparison. Cash flow from operating activities (the GAAP measure) increased strongly from the previous year. The absence of hedging losses and annual maintenance clearly boosted the comparison even before the effects of stronger pricing.

The second quarter will compare to a very strong second quarter in 2018. Therefore, the market may perceive a weak comparison without considering that the Spring Breakup costs will return to the traditional second quarter. Normally, annual maintenance and major repair activities are done during that traditionally slow period of time. Fiscal Year 2018 was an exception as the company reported turnarounds and other repairs in the fiscal first quarter.

Source: Cenovus Energy First Quarter 2019, Earnings Conference Call Slides

Still, the adjusted funds flow points to a potential annual cash flow in excess of C$3 billion for the fiscal year. Ever since the acquisition from ConocoPhillips, cash flow has improved (in lumps) over the before acquisition period. This year cash flow appears to be on track for at least a 50% jump over the previous fiscal year. As a result, management is forecasting the payment of about C$3 billion in debt this fiscal year. That cash flow could exceed C$4 billion easily if pricing remains strong and the other profit enhancement initiatives unfold as planned.

Operational Improvements And News

Thermal costs appear to be rock bottom for the industry. In fact, they are low enough to compete with some of the better light oil industry cost leaders. Since the produced product sells at a discount to WTI, those low costs are an essential competitive characteristic.

Source: Cenovus Energy First Quarter 2019, Earnings Conference Call Slides

Since the acquisition from ConocoPhillips, costs have headed down. Not only are operating costs improving, but capital costs have dropped significantly to some of the lowest levels in the industry. Those low costs could make Cenovus Energy a takeover target should the continuing low stock price persist. Most acquirers want a good deal with few problems. This company has streamlined its operations massively since the acquisition but the market could care less. That kind of indifferent market attitude often sets the stage for an acquisition.

Source: Cenovus Energy First Quarter 2019, Earnings Conference Call Slides

The company enjoys lower decline rates largely because ConocoPhillips ignored this part of the portfolio before it was acquired by Cenovus Energy. Older production declines less. That older production also has higher costs. Cenovus notes that the mostly gas production costs at least C$8 BOE to produce. That will not be changing until the takeaway issues are resolved. Some of those issues should go away this year as more pipeline capacity comes online in 2019. In the meantime, the production cash flows.

That means that costs will decline as newer wells with improved technology and production results will lower average costs. Cenovus Energy has also aimed for more liquids production from this acreage. As that push towards more liquids succeeds, this acreage will increase in value. This part of the acquisition becomes a better bargain.

Source: Cenovus Energy First Quarter 2019, Earnings Conference Call Slides

Most importantly, Cenovus uncovered a conventional oil opportunity in the oil sands area. The size and profitability of this discovery has yet to be completely determined. However, the find is significant enough to be announced. This discovery has the potential to shift the company product mix towards higher revenue products per BOE.


Shareholders should expect the company to continue to find ways to cut costs and increase profitability. Most likely this company will build or acquire more refining capacity to further insulate itself from the volatility of WCS pricing. On-site upgrading capacity would be another area of improvement that would increase cash flow and profits during periods of low pricing.

In the meantime, this year looks excellent for the company. Cash flow could conceivably top C$4 billion. Continuing growth prospects make this stock a bargain under those circumstances.

Enterprise value is about C$22 billion. Therefore, the enterprise value is a little more than 5 times the projected (possible) cash flow. As the Canadian headwinds and challenges decline, this price should look more like a bargain.

Debt will decline this year materially. The company has taken some properties off the market as a show of faith in the current pricing strength (and probably lack of decent bids as well). Even if more properties need to be sold, this company shows decent production growth over the last three years. There are plenty of growth opportunities despite recent headlines over Canadian oil problems. The time to buy is when the merchandise is on sale. Remember that most institutions will not be interested until the stock rises 50% from current levels.

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.

Disclosure: I am/we are long CVE 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.