Editor's note: Seeking Alpha is proud to welcome William McNarland as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Essential. Click here to find out more »
Husky Energy (OTCPK:HUSKF) is a Calgary, Canada-based integrated energy company that is currently trading at a 16 year low. The company at this low price also comes with a safe dividend of over 5.4%. The company also has a solid balance sheet that has been improving over the last number of years. Since the companies earnings are diversified with refinery and oil production, it has lower-earning volatility than most oil and gas production companies. The report will consider the material reasons that the company is at a low price and identify the areas that are improving. The companies management is investing heavily in future earning growth of the company that should increase earnings. I believe that Husky Energy stock should significantly increase while investors receive a substantial dividend.
The Stock Is Cheap
As indicated in the following chart, Husky is trading at a 16-year low. According to the TMX Group, Husky was trading at a PE Ratio of 6.5X based on its closing price on August 7, 2019. Based on cash flow, the company is trading at only 2.2X operating cash flow.
(Note: All amounts in this report are provided in Canadian dollars.)
Husky is a much stronger and more attractive company today than it was in 2005. Let's compare some key metrics from the 2005 and 2018 Annual Reports. The year 2005 was chosen for comparison because the stock price in 2005 was at the same level as today's price.
Source: All financial data and analysis extracted from 2005 and 2018 annual reports and Q1 and Q2 company financial reports.
When one compares six out of the seven key metrics above, it is easy to conclude that Husky is a much more attractive company today than it was in 2005. The most significant metric to highlight is the fact that the refinery throughput increased 9.9 times from 2005 to 2018. A significant increase in refinery capacity demonstrates that Husky has transitioned from a company focused on oil and gas exploration/production to a fully integrated company that is less risky. The one area of lag is oil MMBOE, which declined from 315.0 to 299.2. Commentary will be provided in the three drags on stock price section, which appears later in this report.
Attractive and Sustainable Dividend With a Strong Balance Sheet
The dividend over 5% is not only attractive but sustainable based on the following five key metrics. First, a total of $645M in net current assets is available to provide a financial cushion if earnings are lower in the future. Second, earnings were $370M in Q2 2019, representing a payout ratio of 34%. Third, cash flow from operations was $760M in Q2 2019, which represents a payout ratio of only 16%. Fourth, there is minimal concern about rolling over the $1.38B in bonds that are coming due within the next year. In the last two years maturing bonds have been replaced by new bonds that have a lower cost of capital greater than 2%. Fifth, a total of $858M was spent on capital expenditures; if necessary, this could be partially curtailed. These five key metrics provide strong evidence that Husky's generous dividend is sustainable.
The balance sheet is proven strong when considering the following five points. First, Husky's debt and preferred shares are rated "stable" by DBRS and were last confirmed on Nov. 15, 2018. While I am not fully confident about any debt ratings, it would be concerning if the trend from the agency were negative or if the company had below an investment-grade rating.
The ratings confirm that the company has a strong balance sheet and a positive outlook with respect to its ability to pay its future obligations. Second, Husky is currently trading at $9.10 per share. The following chart shows the break-up value on a per-share basis. While break-up value can be regarded only roughly, it shows that equity holders would get back about twice the price at which Husky's shares are traded in the marketplace. This provides great protection for shareholders and demonstrates how inexpensive the company is.
Third, Husky's cash per share, current assets and current assets less debt are substantial compared to the companies market capitalization. When compared to its stock price of $9.10, the company has a significant amount of liquid assets on hand that will provide sustainability if earnings drop in the future.
Fourth, Husky has a total long-term debt of $4.59B. Its short-term debt with a mature date one year from June 30, 2019, is $1.35B. This represents a total debt value of $5.94B or $5.94 per share. The following table determines the payback period by comparing the company's debt per share to its earnings and cash flow per share. This metric shows that the company's long-term debt could be paid back over the next few years. It indicates that management is using a prudent amount of debt.
Fifth, Husky has a strong track record of refinancing its long-term debt. For example, the company had $365M in bonds matured with a coupon of 6.20% on Sept. 15, 2017. On March 10, 2017, Husky secured $750M USD of 10-year debt at 3.6%. This was five months before the bond's redemption. Again, on March 13, 2019, the company secured an additional $750M USD at 4.4%. Both transactions demonstrated Husky's strong ability to refinance at a lower cost of capital. In summary, from the standpoint of credit rating agencies' perspective, break-up value, liquidity, debt load and the ability to refinance its debt, Husky's balance sheet is strong.
Earnings Correlations and Sensitivities
Husky's earnings are correlated to the following main factors. The ranking is by order of sensitivity.
- WTI Price
- FX Rate (US $ per Cnd $)
- Chicago 3:2:1 Crack Spread
- Canadian Asphalt Margins
- WTI/Lloyd Crude Blend Differential
- Canadian Light Oil Margins
The company is not sensitive to the price of natural gas. The amount of natural gas it produces equals the amount it consumes in its refinery and other operations. The following table demonstrates what would happen to earnings if each main factor moved negatively against the company. The table also shows how material each variable is in influencing the company's earnings. The calculation assumes that each key factor moves 10% in a negative direction. For example, the price of WTI drops by 10% and the Canadian dollar increases by 10%. The table below calculates the negative effect on earnings.
The above table demonstrates that though the price of WTI is a major factor influencing Husky's earnings, it is still less than 50%. Because oil is Canada's largest export product, the Canadian dollar is correlated to the price of oil. The Canadian dollar has an inverse correlation to WTI and moves in the opposite direction. This natural hedge helps even out the drag a low WTI price has on earnings. The following table provides additional insight into the lack of correlation in the key variables. The table shows that the variables experienced multiyear lows and highs in different years.
Husky has less volatile earnings compared to most oil and gas exploration and development companies. This is because its six main earnings-influencing variables are non-correlated. Most oil and gas exploration companies' earnings are highly dependent on the prices of either oil or natural gas.
Management Strategies to Increase Future Earnings
Husky's earnings are not driven only by the six variables mentioned in the last section. They are also affected by managements' plans and executions. Following is a list of six management strategies which should increase future revenue outside the pricing of the six variables.
The company focuses on capital expenditures that will increase future oil production. In 2018, $3.6B, or $3.58 per share, was allocated to capital expenditures. At Husky's current stock price, this represents 45% of its market capitalization, which will create tremendous future earning power. The four main areas of investment are:
- Lloyd Thermal Projects in Saskatchewan, Canada
- West White Rose Project in Newfoundland and Labrador, Canada
- Accelerating Planned Drilling Program for Assets in Western Canada
- Liwan Gas Project in the South China Sea
With a strong balance sheet and the ability to raise bond capital at a low-interest rate, management will consider acquisitions. Many struggling oil and gas exploration and production companies are in poor financial shape but have some attractive assets. The company demonstrated discipline in its negotiations with MEG Energy in 2018. It let the offer expire after MEG shareholders tried to sweeten Husky's offer.
Strong cash flow from operations allows the company to spend aggressively in a capital expenditure plan that will produce future higher earnings for years to come. The strong balance sheet will also allow the company to consider acquisitions if the terms and price are attractive.
The Three Drags on Stock Price
The following events in the last 18 months are causing a drag on Husky's stock performance. I will share my perspective on each of them. First, the company is often lumped into the general selling pressure that the oil and gas sector is experiencing. The following chart from the SPDR S&P Oil and Gas Exploration and Production ETF (NYSEARCA:XOP) illustrates how poorly the stock prices are in this sector. As you can see, the price of the current ETF XOP is revisiting the lows of late 2008 and 2016. It is very far from the peak prices in early 2008, 2011 and 2015. In fact, it is only half the price of that in fall 2018. We cannot predict the future value of XOP, but we are certain that much of Husky's stock decline is due to general selling in the sector.
Second, there has been political decisions that have negatively affected earnings. On Dec. 2, 2018, the provincial government of Alberta, Canada, led by the left-leaning New Democrat Party, mandated that oil production in the province be curtailed by 8.7% to help increase the local oil price. This was negative for Husky, as it would decrease its production and cash flow. On April 16, 2019, the people of Alberta elected the right-leaning United Conservative Party (NYSE:UCP). The UCP is slowly unwinding this legislation and, since being elected, has allowed companies to increase their production each month. The UCP has also reduced corporate income tax, which will provide relief for the companies. I believe that the local political pressure with respect to the lower stock price is in the past and will no longer be a drag on Husky's earnings.
Thrid, Husky experienced two material environmental disasters in 2018. While the potential financial loss is unlikely in the future, a dark cloud still lingers over the company's reputation.
- On April 26, 2018, there was an explosion and fire at the Superior Wisconsin refinery. There were no casualties and the company accrued pre-tax insurance of $27 million to recover property damage associated with the incident.
- On Nov. 16, 2018, Husky was responsible for an offshore leak of 250,000 liters of fuel near the White Rose extension oil well in the Canadian province of Newfoundland and Labrador. The company is a very important employer in the region and no material negative financial repercussions were expected.
These two incidents were material and rightfully caused the company's share to fall. While they are very serious environmental issues, as each day passes, there will be less overhang on the stock price resulting from them. Overall, two of the three major drags on Husky's stock price are either a concern of the past or will improve with time.
Husky, at its current stock price, with attractive dividend and strong financial positions, shows an excellent value. However, investors should be mindful of the key risks. First, the stock price could be dragged down by lower commodity prices or falling prices in the energy sector in general. Second, if the six key sensitivity metrics move in unison negatively, Husky's future earnings could significantly decline. Third, any future environmental incidents would negatively affect the future stock price. Fourth, we are more than 10 years from the last recession and are close to an all-time high in the stock market. If stocks in general fall, the price of Husky would likely be negatively affected as well.
In conclusion, Husky Energy presents a compelling opportunity to invest. The stock price is at a 16-year low and has a sustainable dividend of over 5%. The company has a strong balance sheet and its earnings are much more diversified and stable than those of most oil and gas exploration and production companies. The overhang contributing to a low stock price may soon be forgotten and management has been aggressively investing in capital expenditures that should increase future earnings.
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.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.