EUR 850.00 For Business Accounts Only

Morningstar | Husky’s Downstream Disappoints, but Stock Looks Fairly Valued

Despite a favorable refining environment, no-moat Husky Energy reported third-quarter free cash flow of CAD 350 million, a slight decline from the year-ago quarter and down CAD 150 million sequentially. Lower free cash flow was driven by increased dividend payments coupled with lower downstream throughput because of maintenance at Lima and the temporary shut-down of the Superior refinery. Ignoring first-in-first-out gains and losses, U.S. refining margins increased to $17.86 per barrel from $13.24/bbl in the previous quarter. The increase is positive, especially with the narrowing of the heavy oil discount, but the company couldn’t take full advantage of the increase because of the maintenance expenses. We expect an uptick in cash flow from refining operations during the fourth quarter and into 2019.

Husky continues to prioritize netback maximization in its upstream operations. Accordingly, the company continued lower heavy oil production in response to the heavy oil discount remaining at high levels, despite its decrease. During the quarter, production averaged 297 thousand barrels of oil equivalent a day, below our previously lowered expectations.

During the quarter, MEG Energy’s board rejected Husky’s acquisition offer. However, Husky will continue to pursue the acquisition directly with MEG shareholders. Husky’s offer remains open for acceptance until Jan. 16, 2019.

Despite the disappointing downstream results, we expect better things to come as the heavy oil discount remains wide. Accordingly, we are maintaining our $15 (CAD 20) fair value estimate. The stock was down over 1% on the earnings news, as the market responded negatively to the disappointing downstream results. However, Husky’s stock is still trading near our estimate, and we see minimal upside for investors. While we don't see upside in the stock, investors can collect a stream of cash flows that approximates a 2.7% dividend yield.

As a reminder, Husky proposed to acquire all of the outstanding shares of MEG Energy in a deal valued at CAD 6.4 billion. Under the proposal, MEG shareholders would receive CAD 11 in cash or 0.485 of a Husky share, subject to a maximum cash payment of CAD 1 billion and a maximum of 107 million shares, and Husky would incur CAD 3.1 billion in debt.

For a detailed look at Canadian crude and pipeline trends, please refer to our September Energy Observer "Don't Overlook Oil Sands: Falling Costs and More Infrastructure Will Make Canadian Production Globally Competitive."