CVE – Divestor

Cenovus Energy preferred share redemption

Cenovus Energy called their remaining preferred share issue (TSE: CVE.PR.A/B, inherited from the Husky Energy transaction) and it will be redeemed out at the end of March.

Notably, the preferred share was incredibly low-yielding: 2.577% and a rate reset of 1.73% above the Government of Canada 5 year.

At today’s GoC 5yr at 2.68%, the preferred share would have reset at 4.45% yield at par.

Yesterday, the preferred shares closed at $24.75 (a mild discount to par). The redemption at $25 is obviously the company deciding to clear out the books entirely on one class of its securities.

A 4.45% after-tax drain, at a notional tax rate of 25% is the equivalent of issuing a perpetual debt at 5.93%, notwithstanding the 5 year changes in the reset rate – a 1.73% spread is quite narrow.

This is extraordinarily cheap capital, yet it is being redeemed. Despite blowing a bunch of cash on the MEG Energy transaction (don’t get me wrong – it was strategically the correct thing for the company to do), Cenovus has ample cash and free cash flow to spend $300 million to save $13.35 million after-tax annually.

This kind of exemplifies the yield wasteland in the preferred share market in general.

More consolidation

This has been quite a year for mergers.

Teck (TSX: TECK.b) is on the way (although definitely not confirmed) to being acquired by Anglo American (possibly to be Anglo Teck). There is a 16% merger arbitrage spread still going on, reflecting the regulatory uncertainty – but I do think this will be passed.

I have written ad nauesum (for years) about MEG being taken over, and Cenovus (TSX: CVE) was finally the suitor. Husky Energy (which itself was taken over by Cenovus) originally took a shot at MEG more than half a decade back. There were other oil patch consolidations I will not write about here which went through consolidation mergers.

Telus International (TSX: TIXT) was majority owned by Telus and Telus was able to re-absorb it into the main entity.

I recently wrote about Laurentian Bank effectively selling itself off to a couple institutions, one of which was National Bank (NA).

On the heels of this, a couple days ago Equitable Group (TSX: EQB) announced that they were acquiring Loblaws’ (TSX: L) PC Bank business and Loblaws is taking a minority stake in Equitable.

Finally, Canfor (TSX: CFP) announced it is proposing to take over the 45% interest in Canfor Pulp (TSX: CFX) that they did not own, for a 20% premium to market, and an option to take cash or shares of Canfor – looking at the balance sheet and the state of the pulp market (which is seemingly deader than 8-track audio), their minority shareholders are quite likely to proceed with this consolidation. Canfor itself tried to take itself private in 2020 and failed by a few percentage points on the shareholder vote – is this far behind?

What is causing all of this? Natural economic forces, but also that credit is cheap and plentiful if you have it – Canadian Natural Resources, for example, just issued $1.65 billion in 3, 5 and 10 year debt at a spread of about 85bps, 100bps and 130bps to GoC equivalents, respectively – dirt cheap!

I see the preferred share market is quite low-yielding – the spreads between yields to corporate debt has narrowed significantly over the past couple years and many of the issuers have their shares trading well above par value (e.g. most of the PPL.PR.x complex, FFH, BIP, etc.) – they are being called out at their 5-year rate resets.

High prices means low yields, and in order to get higher returns, one has to venture further up the risk spectrum. It’s getting quite competitive out there.

The merged Cenovus/MEG Energy entity

This is simply a compilation of known information. No special insights in this post.

Now that Cenovus is the ‘winner’ of the MEG sweepstakes, what will be the merged entity?

MEG has 255 million shares outstanding. CVE is paying $14.75 cash and 0.62 CVE shares for MEG, or approx. $3.8 billion cash and 158 million shares of CVE.

With dilution from warrants that are highly in the money, CVE will have approximately 1.98 billion shares outstanding after this transaction.

Balance sheet-wise, CVE announced after the sale of their 50% interest in one of their jointly owned refineries netting $1.8 billion, which gave their Q3-ending balance sheet a $3.5 billion net debt pro-forma. CVE purchased $512 million of their own stock in September. After the MEG acquisition, which had about $617 million in net debt at the end of Q2-2025, CVE will have approximately $8.4 billion in net debt pro-forma post-acquisition.

MEG’s production was estimated to be 100,000 boe/d; CVE’s production was estimated to be 800,000 boe/d, hence the combined entity will be approximately 900,000. Combined FCF for 1H-2025 is $1.56 billion, annualized $3.1 billion (noting WTI pricing is considerably lower today than it was in 1H-2025). This assumes no cost synergies when the assets get merged (in reality, there will be considerable synergies to be had with the Christina Lake project being so geographically close, and they will also be able to make proper capital allocation decisions in the whole geography instead of in isolation – MEG was going to blow some money on raising the production and this project is likely to change scope after the acquisition).

At WTI at US$58, I have the FCF of the combined entities at roughly $2.8 billion, but for the purposes of this analysis I will use 1H-2025 numbers.

Analysis: The pro-forma entity currently has an EV of about $55 billion at current market prices; net they are trading at about 18x EV/FCF, which historically has been higher than the typical high single-digit multiples seen in earlier years for most Canadian oil and gas companies. CNQ, notably, is sitting at around 12x EV/FCF on their annualized 1H-2025 numbers – if they creep much lower they might be a reasonable ‘low risk, low reward’ type candidate for incremental capital.

There is likely a considerable amount of value baked into the asset base (which is top-tier low steam-to-oil ratio, i.e. low cost production with most capital already spent) and there is considerable balance sheet value baked into the combined entity. This completes what was attempted nearly a decade ago when Husky Energy tried to take over MEG Energy in 2018. Now it is likely to be completed. The combined entity will be one of the premiere low cost oil sands production companies and should be quite income trust-like in nature, similar to how the old Canadian Oil Sands Trust used to trade (TSX:COS.un if anybody remembers those days – they got bought out by Suncor). The only question is a matter of valuation in this ‘price-taker’ market – WCS differentials are once again creeping higher (about US$13/barrel as I write this).

It is going to be difficult for high-cost producers (shale, and most conventional drillers, and the high steam-to-oil ratio oilsands) companies to make money in the existing environment. One reason why I suspect Strathcona was so desperate to acquire MEG, aside from trying to dump their own stock to MEG shareholders, is because their own assets are marginal (many acquired through prior CCAA or near-CCAA discards such as the old Pengrowth Energy) and will not be doing well in a low price environment – their common stock to me seems frothy. One advantage of the top four dogs in Canadian Energy (CNQ, CVE, SU, TOU) is their ability to make a little money in a low price environment, and making a lot of money in a high price environment. The forward-looking return should be better than the 3.1% that you can currently get for a 10-year Government of Canada bond. If we do get some energy crisis, there is embedded optionality which seems to be underpriced – of course, the painful trade when this occurs is selling the shares when they are trading at 4 times free cash flow.

The MEG sweepstakes, revisited

You know you’re starting to get old when you consistently start reciting your own work from years on back.

Does anybody remember Husky Energy (now consumed by Cenovus Energy) tried to take out MEG Energy at $11/share in 2018?

Subsequent to this, I wrote about MEG’s pending takeover in May and December of 2021 where I speculated that Cenovus was the most likely strategic acquirer of MEG Energy. There are significant synergies with the acquisition, including geographical ones (Cenovus and MEG Energy are side-by-side at Christina Lake, Alberta):

(MEG is on the north-eastern end of the lake, CVE is on the southern and northern end, and CNQ is on the southwestern end)

For those unaware, these oil sand assets are the crème de la crème of the Alberta oil sands – they have the best steam-to-oil ratios out of all the oil sands. As most of the capital has already been spent on the projects, they will be generating cash flows for decades. It cannot be understated how valuable this asset is whether oil is trading at 50, 75 or 100 a barrel – they are the lowest cost production fields in North America.

Indeed, I wrote those articles when MEG was $12/share and my very pithy analysis speculated that one of CVE or CNQ would just do a 30-40% premium buyout and get it over with. This would have been about $17/share equivalent. The only element that has changed since then (the commodity price environment round-tripped after the Russian invasion of Ukraine, and when adjusting for Canadian currency and the narrower WCS differential the price is virtually the same today as it was back then) is the price being paid – roughly speaking, $5.2 billion in cash and 84 million shares of CVE for a grand total of about $7.2 billion at today’s market value of CVE or about $28/share for MEG.

This is a very unusual transaction considering that Strathcona’s offer was originally higher than Cenovus’ offer, but the even more shocking factor to me is that Cenovus is trading higher after delivering a lower bid than Stratcona, which MEG agreed to!

I wasn’t expecting this set of circumstances to be on my bingo card.

When running my paper napkin calculations, it will be a synergistic acquisition. Just looking at an apples-to-apples comparison in 2024, CVE trades at 11x EV/FCF, while MEG trades at 10x – this is using the currently elevated share prices at August 27, 2025.

There are other synergies – there are plenty of greenfields in the MEG geographical footprint to facilitate the maintenance of their SAGD projects, TMX allocation, and tax shield assets which will deliver quite a bit more cash flow to the underlying Cenovus entity (not to mention the cost elimination of a management layer). The CVE cash portion will be funded by low cost (and tax deductible) debt and the leverage situation after the acquisition is still modest. Finally, MEG in the end of 2024, in an attempt to appear relevant, announced they would spend about half a billion dollars in what they titled a “Facility Expansion Project”, adding 25,000 boe/d of production in a few years – presumptively this project will be canned as half a billion dollars is one hell of an opportunity cost when you have a limited geographical footprint like MEG did (not to mention egress issues).

Strathcona will also get a tactical victory by virtue of its short-term investment in MEG paying off, but strategically they are still looking for ways to tap into the very valuable market of having enough of a stock float to be picked up by index ETF investors – I am absolutely sure they will be on the prowl in the oil patch to boost their own liquidity. At this point the only other obvious target that is publicly traded is Athabaska Oil Sands (TSX: ATH), but they’ve received too much of a bid recently in anticipation of exactly that.

What is ahead in the Canadian fossil fuel industry?

From a broad strategic perspective, the next logical merger would be Cenovus and Suncor. The major synergy here is with the refining networks both companies have – internal consumption of your own product hedges against the inevitable egress risk that will be coming up later this decade. Irvine, Valero, Shell and Imperial Oil would still be primary competitors in the refining space.

Modelling commodity companies

I’m not much of a technical analysis guru but here is my depiction of the trendline of Cenovus Energy (TSX: CVE):

Will this go on forever and end the year at $70/share? I wish, but incredibly unlikely unless if we’re heading into Weimar Republic inflation.

Despite this price rise, the company is still relatively cheap from a price to free cash flow metric. You don’t need to have a CFA in order to do some basic financial modelling:

This is from their IR slides and they will be spending $4.8 billion on capital expenditures in 2024. At “Budget”, which is WTI US$75, and US$17 differential to WCS pricing, the company will do roughly $10 billion in operating cash flow, leaving $5.2 billion of it free. They also have a sensitivity of $150 million per US$1 of WTI.

Everything being equal (it is not, but this is a paper napkin modelling exercise), at today’s closing price of WTI at US$86.75, they’re looking at a shade just under $7 billion in free cash flow. It won’t be quite this high in reality, but that puts the company at around 8.5xFCF to EV even at the current price. If you were smart enough to buy it at $20/share back in mid-January, at the price of WTI then (US$72/barrel), your FCF to EV ratio would have been… about 9x.

In other words, the price appreciation is strictly a result of the commodity price improvement, coupled with a very small multiple decline (which the truer computer models out there which algorithmically trade all these fossil fuel companies on a formulaic basis perform).

For the fossil fuel components in my portfolio, I have pretty much given up on any other smaller companies other than the big three (CNQ, CVE and SU) simply because I have little in the way of competitive advantage to determine which one of the smaller companies have better on-the-ground operations and superior geographies to work with. They all trade off of the commodity curve one way or another. The “big three” are low cost producers and will generate some amount of cash going forward, barring a Covid-style catastrophic environment.

They are basically the equivalent of income trusts at the moment. Remember the old Canadian Oil Sands (formerly TSX: COS.un) before it was absorbed into Suncor? That’s exactly that these three companies are – they all have gigantic reserves and very well established low-cost operations, and capital allocation that is simply going to dump cash out to dividends or share buybacks.

Risks inherent with all three:
1. A common regulatory/governmental risk being located in Canada, and mostly Albertan operations.
2. Fossil fuels may be subject to displacement if we actually see some sort of renaissance on nuclear power (there are whiffs of it here and there, but going from speculation to reality is another matter entirely).
3. The usual cyclical supply/demand factors.

With point #3, I see in the presentation decks of most of these companies (especially the smaller ones) that they are very intent on increasing production. Despite the fact that TMX is going to be operational in a month, the egress situation out of Canada will once again saturate. No more refineries are being built and thus the demand-supply variable will likely push WTI-WCS differentials higher at some point in the near future. With balance sheets of all the companies stronger than they ever have been, there will likely be some “race to the bottom” effect coming in due course, similar to how the domestic natural gas market has been saturated – both AECO and Henry Hub commodity pricing are quite low and LNG export pricing is back to its historical levels (around US$9.50/mmBtu spot).

I think what will happen is that the higher capitalization companies will use their relatively stronger balance sheets to pick away at the entrails of the smaller, higher leveraged operations when the price environment goes sour. Given the overall under-leveraged bent most of these smaller companies have been taking as of late, this process going to take awhile and a lower commodity price environment to achieve. These are not “forever hold” companies, but certainly at present their valuations continue to look cheap.