EUR 850.00 For Business Accounts Only

Morningstar | Best Idea Cenovus Energy: Not So Fast With Rail, but Plenty of Upside Remains

Best Idea Cenovus Energy announced that rail agreements are taking longer than expected, and it’s unlikely to be utilized in 2018. Management remains confident that they will be able to strike a deal in 2019 and signaled that the agreements could contain 50-60 mb/d obligations over multiple years. The heavy oil differential narrowed during the quarter to $18/bbl from $26/bbl during the first quarter, providing some relief for bitumen realizations. However, we expect the discounts to widen in the second half of the year with production from Syncrude set to come back on line by September. Accordingly, Cenovus’ netbacks will suffer until it can enter into rail agreements.

Despite anticipated lower price realizations, we are maintaining our CAD 21 fair value estimate, but lowering our U.S. dollar fair value estimate to $16 from $17 based on changes in foreign exchange rates. We still see tremendous upside in the stock. We believe the market is too narrowly focused on the company's temporary increase in short-term leverage and is overlooking the immense growth potential in its oil sands reserves that can be brought on line with solvent-aided process technology. We are maintaining our no-moat rating.

We caution investors that the stock could retreat in the medium term if oil prices fall to our midcycle estimate of $55/bbl or if the heavy oil discount remains high. We remind investors, though, that these assumptions are already priced into our model. We expect lower price realizations over the next few quarters, coupled with higher leverage. However, we expect the heavy oil discount to narrow as producers take advantage of rail options in 2019 and pipeline expansion projects are placed into service. Furthermore, we still expect Cenovus to reach its desired leverage target of less than 2 times net debt/EBITDA by the end of 2019. At that point, we expect the company to begin its industry-leading, solvent-assisted technology growth projects.

Cenovus’ second-quarter production averaged 518.5 mb/d, ahead of our expectations. The increased production was driven by mobilization of production that was stored in the company’s oil sands reservoirs. Management still expects to meet its 2018 target production of 480-510 mb/d, in line with our forecasts. For a deeper look into Cenovus and its upside, please see our October 2017 report "The King in the North: Cenovus Energy."