CVE – Divestor

Oil and gas cash flows

What a difference a few Iranian air strikes (coupled with UAV’ing the Russian refinery industry) has on the profitability of domestic oil and gas companies.

I am looking at Cenovus Energy’s Q2 financial statements and see approximately $5.4 billion in free cash flow generated in the first half. This is well above the $3.3 billion generated in the full year of 2025. The MEG Energy acquisition has resulted in a rounding error now on the balance sheet with most of the debt being paid back and shares repurchased almost to the point before the acquisition (about 25 million shares away). Clearly wrestling away this company from Strathcona Resources was a strategic masterstroke. The refinery business has turned around, from generating a $706 million loss in the first half of 2025, while generating a $1,374 million income in first half 2026. This is one hell of a swing, mainly due to crack spreads trading at elevated values.

Annualized, the company is on track to generate about $5.90/share in free cash flow, which puts it at around 7x free cash flow, or a total yield of about 14.5% on the current CAD$40.60/share price. Valuation-wise, I can see why management continues to dump excess cash into the stock rather than accruing it for a special dividend.

However, always be cautioned that this is subject to the cyclical whims of the marketplace – many a dollar has been lost investing in cyclical companies at low price to earnings multiples. My gut has this as a “too cheap to sell, too expensive to buy” situation although if you can model the situation going on in the middle east correctly, you will stand to make a small fortune. I was eyeballing adding to some CNQ at the end of June/early July valuations for some idle cash deployment but was too lazy on the switch.

It has been noted that the US’s strategic petroleum reserve‘s balances have dwindled to record lows not seen since the early 1980’s – once this tap shuts off, this artificial amount of supply will shut with it and domestic crude prices stands to marginally rise – let alone the demand increase if the government wishes to refill it. The SPR is filled with both light and heavy crudes and North American demand will rise as a result if the reserve is ever to be refilled.

Finally, I note the crude oil curve remains extremely bent – a barrel in September 2026 is US$84.75, while a barrel in December 2027 is US$70.00 – a 17.4% discount for 15 months’ time. Short today, cover tomorrow – if you can find the supply.

Spot oil windfall

When will we start hearing, once again, “Windfall profit taxes” in relation to oil prices?

Eyeballing the chart, we have spot WTI US$60 for January, US$65 for February and so far in March, let’s call it US$85.

Just as an example, we look at Cenovus’ sensitivities:

CAD$220M/year in “adjusted funds flow” sensitivity per dollar of WTI, so a first-cut analysis of a US$20 one-month change in WTI would be about CAD$370M in cash flow, or about 20 cents a share. For a single month of elevated pricing.

Suncor is about C$215M/year per US$1 change in WTI. CNQ forces you to do your own homework, but very roughly, my paper napkin has a model going from US$65 to US$85 WTI resulting in a change from $4 to $7/share in free cash flow (assuming things go for a whole year).

Given the extreme slope on the oil futures curve (spot oil being US$88, give or take, while December 2026 crude is US$75, a 15% discount for patiently waiting 9 months for your delivery), this windfall is not expected to last. Or will it?

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.