Cenovus (TSX: CVE) reported quarterly results.
The salient detail is that in addition to spending $2.6 billion in share buybacks and dividends, they are able to get net debt down from $9.6 to $5.3 billion for the 9 months. Specifically they have $8.8 billion in debt and $3.5 billion in cash.
They have a framework that gives off half the excess cash flow to buybacks and variable dividends. For Q3 this was allocated 75% to buybacks and 25% to the variable dividend.
In the conference call they alluded to this mix depending on the projected returns on the equity, which suggests a price sensitivity to their stock price.
This is exactly how they should be thinking. There should be a point where they stop buying back shares and instead just give it out in cash. At CAD$28/share, that point is getting pretty close.
They have a stated objective of dumping half their excess cash flow into their framework, and once net debt heads below $4 billion, then it becomes all of their excess cash flow. This should happen by the end of Q4.
While I believe a 100% allocation is not the wisest (they should top it out at 90% and focus on eliminating the debt entirely), given the maturity structure of their outstanding bonds, there is zero term risk in the next decade and a half (with their existing cash balances they can tender out the rest of their debt until 2037).
Once they start distributing 100% of their excess cash flow to dividends and buybacks, Cenovus will effectively function as an income trust of yester-year where you had Penn West and Pengrowth consistently giving out cash distributions. The buyback algorithm should auto-stabalize the stock price. At US$90 oil and refining margins sky-high and with little signs of abatement, Cenovus is on track to generating $8 billion in free cash flow for the year. Very roughly, that is about 14%/year and this is much higher than I can recall the historical income trusts yielding.
Unless if the stock price gets ridiculously high, or if management starts to display capital management that is off-colour (i.e. going on acquisition sprees that do not make sense), this is going to be a core holding for a very long time. It is too expensive to buy and too cheap to sell, so I look forward to collecting the cash distributions where I will try to find a better home for.
Hi Sacha,
are refining margins sky-high though? CVE’s net refining margin is 6% and 5% (CAD and US) correspondingly, based on 9m segment disclosures. To me this is “fair” margin at most (e.g. oil sands return 17%+), so am I missing something? I’m not taking into account assets of both segments, assuming both just need maintenance and no significant investments.
CVE just needs to make sure their refineries don’t explode all at one time. First Superior, now Toledo… the negotiations with BP there are going to be interesting to say the least.
By “sky-high” I’m referring to crack spreads which are quite elevated.
Hi Sacha,
How would you rank CVE, SU, CNQ based on the company quality and their stock as an investment?
They are all great companies. A generalist investor wanting exposure to liquids and refining can do far, far, far worse than to just put 33/33/33 in each of the three and forget about it. You have exposure to WTI, WCS, Brent, gas (CNQ) and refining (SU, CVE). All three have gigantic reserves and good cost structures.
To me CNQ seems to be the safest bet: performance & dividend history, stable & reasonable growth, bright management. Minus – lack of diversification.
SU – great assets, fair diversification, mediocre management, bad reputation.
CVE – least clear from all 3. On paper it should be perfect from the business structure & management perspective. However, I sometimes struggle to link their potential on paper with actual performance.
PS: I really hope WCP becomes “next CNQ”.
Re: CVE, Foster Creek / Christina Lake are top-tier assets. The refinery operations they got from Husky, lesser so, but still are something.
Hi Sacha,
Would you mind sharing your thoughts on CVE’s latest results? Delay in 100% fcf return to Q3 isn’t ideal but I’m surprised by the selloff.
Obviously retail (including myself) was expecting a jack-up in the dividend, but either way we will see returns (via buyback or dividends) eventually going forward, barring a total collapse in commodity oil prices.
The Superior refinery re-start, coupled with a firm timeline with the Toledo restart was the most positive thing coming out of the quarterly result. The conference call was illuminating. Financially they’ve guided that there will be a $1.2B cash outlay for taxes (a ‘problem’ to have if you earn money) and also closing on Toledo (CAD$400M) very soon, the contingent payments on Sunrise oil sands, and the Capex on the NL offshore project.
At US$75 WTI they will still be making plenty of money. Also note they’ve been stockpiling cash on their balance sheet (about $4.5 billion y/e), so they will likely be on the hunt, perhaps taking over the 50/50 interests in Borger or the Wood River refinery, but this is less likely since Phillips 66 probably is less likely to sell due to ESG pressures.
There are far, far, far worse oil companies to have capital in than CVE at present. The refining operations provide a very good counterbalance to the upstream.
Much appreciated – thanks for the thoughtful response as always. Agreed with your conclusion.