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Morningstar | Best Idea Cenovus Energy Misses Consensus Expectations, but Reports a Strong Quarter

No moat Cenovus Energy reported first-quarter EBITDA of CAD 923 million, which slightly exceeded our expectations of CAD 912 million, but missed consensus expectations of CAD 993 million. Consensus was expecting higher realized prices from the company’s production. During the quarter, the company benefited from Alberta’s mandatory production curtailments and reported realized prices at Foster Creek and Christina Lake of CAD 52 per barrel and CAD 47.60/bbl, respectively. We see the price realizations as a positive near-term surprise, in spite of consensus’ expectations. However, the increased revenue was partially offset by higher operating costs. Even with mandatory curtailments, Cenovus is maintaining its steam/oil ratios, which resulted in higher operating costs than we expected. Accordingly, the company increased its 2019 operating cost guidance range by CAD 0.25/bbl for Foster Creek and Christina Lake to CAD 8.25-CAD 9.75 and CAD 6.25-CAD 7.75, respectively. As such, we increased our 2019 and 2020 expense forecast.

Upstream production averaged 447.3 thousand barrels of oil equivalent per day, up 3% sequentially but slightly below our expectations. The lower-than-expected production was driven by voluntary curtailment of the company’s oil sands production, which we applaud amid the historical lows in heavy oil pricing. Cenovus continues to safely store barrels in its reservoirs for future sale to help offset future turnarounds and take advantage of potential market access opportunities. Additionally, the company also lowered its 2019 oil sands production by 7% in the range of 350 to 370 mbbl/d, which is consistent with our revised forecasts.

We are maintaining our $14 (CAD 19) fair value estimate and no-moat rating. We don’t see the slight increase in operating costs as a needle mover.

Despite the strong quarter, the stock is down 2% on the earnings miss, which we think is an overreaction. Year to date, the stock has appreciated almost 45%, leading to increased near-term expectations. However, we think Cenovus’ value lies in its future solvent-assisted production. While the market continues to overlook this production prospect, we see the dip as an opportunity for long-term investors to capitalize on the stock's immense upside. The stock is currently trading at a 30% discount to our fair value estimate. The temporary increase in leverage, exposure to the heavy oil discount, and most of the cash flow benefits from SAP being several years away is causing the market to continue its bearish stance. However, we think the stock continues to look like an attractive opportunity for long-term investors.

With market access limited until either the Keystone XL or Trans Mountain Expansions pipelines are built, Cenovus’ top priority is strengthening its balance sheet. During the quarter, the company paid down CAD 550 million of its outstanding debt. Subsequent to the quarter-end, Cenovus paid down an additional CAD 80 million. Management intends to devote all of its near-term free cash flow to further debt reduction. The company’s target is to reduce its total debt to CAD 7 billion and net debt/trailing adjusted EBITDA to 2 times by the end of 2019, which we expect the company to achieve in the fourth quarter. Beyond this year, Cenovus aims to lower its absolute debt to CAD 5 billion, which we expect to occur in early 2021. Once the balance sheet is strengthened, Cenovus will turn its attention to balancing growth and returning capital to shareholders, likely through share buybacks.


For a detailed look into Canadian crude market and pipeline trends, please refer to our January Energy Observer, "Pipelines Are Canada’s Lifelines.”

For a deeper look into Cenovus and its upside, please see our October 2017 report "The King in the North: Cenovus Energy."