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Cenovus Energy: Financial Reasons For Merger


  • The merger gives management a lot of work to do fast.
  • Husky thermal cost ran high.
  • Cenovus needed refining capacity.
  • For the two above reasons, the combined company should be more profitable.
  • The conventional business will take a seat to more important priorities.
  • This idea was discussed in more depth with members of my private investing community, Oil & Gas Value Research. Get started today »

Any large merger can have daunting logistics. For this reason, some have their doubts about the recent Cenovus Energy (NYSE:CVE) merger with Husky (OTCPK:HUSKF). However, there had to be compelling reasons to even attempt a merger of this scale. Now that the annual results are out for Cenovus Energy, some of the reasons look obvious.

Cost Reasons

Cenovus has some of the best thermal costs in the industry.

Source: Cenovus Energy Fourth Quarter 2020, Earnings Supplemental Materials

As shown above, the heavy oil operating costs are extremely low. This meant that the Cenovus refining partnership was getting some very low cost materials to upgrade. Even though the upgrading and refining process adds value to the finished product, the incoming cost still matters to overall company profitability.

Cenovus management estimated many times that the refining capability of the partnership would cover about 25% of the production for Cenovus as a standalone company. A whole lot more product should be upgraded by the combined company after the merger (as opposed to selling the product to another refinery to upgrade or refine).

Source: Cenovus Energy 2021 Budget Slide Presentation January 2021.

This slide shows the additional properties that are now included with the combined company. All of those additional properties in this new slide is high cost. Long term, the combined company will either reduce operating costs sharply or shut down these properties because Cenovus has access to plenty of low cost production.

Husky clearly made money by upgrading the material processed in the refineries owned. Husky would have struggled as an upstream producer selling thermal products on the market. Husky refineries now have access to the lower cost Christina Lake And Foster Creek production.

The cost savings of using lower cost material may not happen "overnight." Husky had far more refining capacity than it

I analyze oil and gas companies like Cenovus Energy and related companies in my service, Oil & Gas Value Research, where I look for undervalued names in the oil and gas space. I break down everything you need to know about these companies -- the balance sheet, competitive position and development prospects. This article is an example of what I do. But for Oil & Gas Value Research members, they get it first and they get analysis on some companies that is not published on the free site. Interested? Sign up here for a free two-week trial.

This article was written by

Long Player profile picture

Long Player believes oil and gas is a boom-bust, cyclical industry. It takes patience, and it certainly helps to have experience. He has been focusing on this industry for years. He is a retired CPA, and holds an MBA and MA.

He leads the investing group Oil & Gas Value Research. He looks for under-followed oil companies and out-of-favor midstream companies that offer compelling opportunities. The group includes an active chat room in which Oil & Gas investors discuss recent information and share ideas. Learn more.

Analyst’s Disclosure: I am/we are long CVE. 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.

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Comments (43)

Jim Wallingford profile picture
I know this is a CVE article but have a look at Enerflex (EFX.to, ENRFF). Would have posted on the last article for them but it was written nearly 3 years ago.
--P/S .66
--Forward P/E 11
--Current ratio 2.19
--Quick ratio 1.48
--Operating cash flow per share (TTM) C$3
--P/CF 2.57 (TTM)
--Cash per share C$1.23
--Debt to equity .31
--Yield 1.03%, payout 13.5%
--Earnings estimates C$.36 FY21, C$.70 FY22
Their most recent earnings release not particularly encouraging: earnings miss, substantial decline in revenue, order backlogs. Hence the ~15% drop last week.
It looks like it has hit a double bottom at $7.29-$7.30. I bought at C$7.47 and C$7.60 with a trailing stop at C$7.13.
With their robust balance sheet and the prospect of improving fortunes in their industry, I'd be "overweight", as the analysts like to say. A very conservatively managed firm as you can see from their dividend payout ratio. They're not trying to buy your votes.
@Jim Wallingford One of Eric Nuttall's favourites. I made a nice gain on them but recently sold out. The Morningstar Quant has their fair value at only C$8 while they give CPG a lot more upside for a very similar business.
Jim Wallingford profile picture
@DrT Not really similar to CPG, which is an oil producer. EFX is in the gas compression business. If you support the "transition fuel" story for natural gas then EFX looks like a winner. I also own CPG, based on the oil price recovery play.
@Jim Wallingford My mistake, I was thinking about enerplus
Jim Wallingford profile picture
That sell-off didn't last long. About 15 minutes. My stop was exercised at C$8.95 then I got back in at C$9.30, reasoning that the strong rebound from below C$9 points to buyers waiting to jump in below that price. My stop is now at C$8.80, 9 cents below the low of today.
RBC reiterated Outperform with a target of C$12, Raymond James the same with a target of C$13.50, JP Morgan lowered the target to C$12 with an underweight rating. Isn't that JPM outlook a contradiction in terms? Up from C$9.36 today to C$12 yet underweight? Hmm...
If these analysts are correct (a big if, granted) we're in for at least a 27% gain from today. I have no idea where we end up but the trend is up. Higher volume would confirm my thesis.
Jim Wallingford profile picture
According to SA the estimate for tomorrow is $-.05 (currency not identified but presume it's CAD) versus C$.07 on Yahoo Finance. Zack's puts it at C$.15 for the quarter. I'm so confused. It's looks like SA is quoting the previous consensus for the year, i.e., C$-.05.
Let's go with 15 cents. That's my favourite.
@Jim Wallingford GAAP earnings for an O&G hardly matter. For a long while the CVE management has said Job 1 is free cash flow and debt reduction. The CEO has already pre-announced it will be a "noisy quarter" because of the merger. That means they will write down acquisition costs, severance costs, anything they can think of. The key numbers will be cashflow and debt reduction. If the headline is "Cenovus posts big loss" while the key numbers look good, it will be a buying opportunity.
Jim Wallingford profile picture
@DrT Yes, but being profitable never hurts.
@DrT Acquisition costs for Q1 came in at 245 million and expected to run 500 million on the year but the good news is no big loss. I think your calls are going to do alright. Congrats.
Jim Wallingford profile picture
New position today at C$9.57 with a trailing stop at C$8.96. On April 21 the low was C$9.03 so going below that I think will be a trend reversal of the current neutral one. This could be a base building period before a move higher (global rebound means more oil consumption) or a move lower if enthusiasm for oil (and stocks) fades. Volume is encouraging today.
There is the COP overhang of 208 million shares to be sold over the next 7 quarters plus the Husky marriage which could turn out to be rocky. Or "accretive" as the brainy analysts like to say.
Often wrong, always in doubt.
Long Player profile picture
@Jim Wallingford One thing to consider is that if COP knows what it is doing (and with that management you can have substantial doubt), then it should be block sales largely outside the market.
@Jim Wallingford Considering a small position in the warrants. Earnings call on Friday, May 7. Depends if COP selling significantly weakens CVE price.
Jim Wallingford profile picture
@krug Hard to predict the COP effect. You're not using margin I assume. You could buy a CVE share for C$2.88 at 30% margin, cheaper than the warrant at C$5.07
Jim Wallingford profile picture
Interesting action today as the TSX volume hits 11 million, nearly twice the 3 month average and 3 times the 10 day. Price holding up well, only down C$.05 as of 3:11pm, having hit a low of C$9.15. Over 12 million traded in NY. Other oil sands names are up 1%+ today (SU, CNQ, IMO). Don't see any news that would explain today's action. Some Generals reducing their positions?
Re-entered today at C$9.45 after my stop got executed at C$9.15 last week. Bottom of the current range around C$9 so my stop is now C$8.91. My theory is that it's finding its footing around the $9 mark and then a move higher. Or I'm wrong and get sold out. In which case I'll wait for a better re-entry point.
Long Player profile picture
@Jim Wallingford sometimes an institution wants in or out and then you have a day like this.
Jim Wallingford profile picture
@Long Player Buyers showed up now. A positive sign I think.
Win win deal for both. Porbaix had stated more than a year ago they wanted to get more refining assets but it would have to wait for debt reduction first. With COVID it may have forced the companies into a marriage of convenience. Obviously they both saw the merits in the deal and that the merged company would be stronger and more valuable. Li Ka-suing has agreed to hold his CVE shares for at least five years.
Oil sands stocks are hated a lot, because of ESG issues. The merger was superb. I am asking myself, if they will grow with other assets, like CLF in steel. Teck wanted to sell their equity on Frontier, 21%. Maybe other majors in oil sand business wanted to sell their assets, when prices are higher. refineries are also thinking about shuting smaller plants. They could have a future for integrated plants ob heavy oil and oil sands. I guess, CVE would get these assets for very small prices.
In ten years, we would have a much bigger CVE, fully integrated, cash flow machine, but low share prices, because of not solvable ESG issues. Like tobacco stocks today.
Very important to have a good balance sheet, so dependence on banks is low.
One future question could be, how can be natural gas implemented in the refineries process to improve output, yields, lower carbon intensity.
Very interesting stock!
Long Player profile picture
@michi1711 Thank you very much. I think you will find that refineries have made a lot of ESG progress and are nothing like they were when I was growing up.
@Long Player
You are right, however from view of the greens, they are dirty, no differentiation.
@Long Player - Great article and thanks for reinforcing the thesis...can you kindly remind me on the status of the COP shares? Have all these been redeemed? I recall this being a hangover which kept a ceiling on the stock. TIA.
Long Player profile picture
@bmrfan As far as I remember, COP still has those. They have mentioned from time to time a wish to sell them But I doubt they would disturb the market. Most likely any sales would go to an institution in a negotiated transaction.
This merger makes real sense. I think the CVE management is very capable and likely gets this done in an efficient manner. The merged companies have similar metrics to SU. If oil averages $60 for 2021 and they execute on the merger I see 15/20 a share by year end. ....Good article.
Long Player profile picture
@AT1010 I actually think the CVE thermal metrics are better than SU. Where SU has done well is the integration. But last time I looked SU at least in some places had higher upstream costs than CVE had before the merger.
Monsieur Greenbubbles profile picture
I wish they would hurry up getting that refinery back working.
Long Player profile picture
@Monsieur Greenbubbles That is going to take at least a year. But the good news there is the insurance money can be used to optimize the refinery going forward. So it probably will come out of this with a higher efficiency.
LONG. Company based the numbers on chicago crack at $13 and they still looked half decent. We are already at 19$ today.. long..... this is a gem. Hold this new refining giant.
Long Player profile picture
@Kareem Farhat I also think the be deal is the refineries will have access to far lower cost feedstock then they had either from the Husky production or even buying off the market which Husky had to do. That is where a whole lot gets missed when looking at the refining even though the refining is correct. Cenovus gets access to the Husky refineries and the upgrading capability which I think they should have had long ago except COP was in far too bad a financial condition to even think about.
I have just several hundred shares so not a needle mover for me but I think they will be successful in this relatively quickly. Rebuilding the refinery and the added pipeline capacity coming on will smooth this even more.
Long Player profile picture
@billknowsall To me this acquisition has tremendous prospects. Now as another article noted, large acquisition have a bad history. So you have to be careful. But to me, what I am seeing here, it looks hard to go wrong history or no history. Plus they gave the light oil discovery to CDDRF to develop which means they should not be distracted from what has to be done. Crow in the refrig just in case though.
Justy72727 profile picture
Thanks for the update long player. I’ve only recently started to follow this company and really need to dig deeper to better understand their path forward
Long Player profile picture
@Justy72727 Thank you. First step is fully integrate the merger
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