Morningstar | Raising MEG Energy's Fair Value Estimate, but Stock Still in 3-Star Territory. See Updated Analyst Note from 02 Nov 2018
We are raising our fair value estimate for MEG Energy to CAD 7.50 from CAD 7 on our improved outlook for the company’s price realizations. However, the stock is currently trading 35% above our fair value estimate. At this time, we recommend that investors remain on the sidelines.As a reminder, no-moat MEG reported third-quarter production of 98.8 thousand barrels of oil per day, above our expectations. Increased production was driven by a faster-than-expected ramp up of the Phase 2B eMSAGP implementation at Christina Lake. However, MEG plans to reduce its fourth-quarter production by 4-6 mbbl/d by advancing scheduled maintenance activities. Despite the decrease, MEG expects to achieve its 2018 production target range of 87-90 mbbl/d, in line with our expectations.
Unlike peers, MEG’s netbacks increased in the quarter to CAD 49.58 per barrel, despite a $10 per barrel widening of the heavy oil discount. Higher realizations are due to stronger sales prices in the U.S. Gulf Coast, where approximately 29% of MEG’s blended sales were delivered. To reach the U.S. Gulf Coast , MEG doubled its rail volumes in the quarter to 7.8 mbbl/d. The company intends to increase its rail volumes to 15 mbbl/d during the fourth quarter and further to 30 mbbl/d during the first quarter of 2019, as it entered into a three-year deal to move up to 30 mbbl/d. The three year-deal carries a one-year extension option, providing MEG with access to the U.S. Gulf Coast if pipeline expansions face delays.
During the third quarter MEG Energy’s board of directors rejected Husky Energy’s bid to acquire the company and urged shareholders to do the same. 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. Husky made the proposal directly to MEG shareholders after MEG’s leadership declined to discuss the bid with Husky. We think this is a good offer for MEG shareholders based on our current fair value estimate. If shareholders reject the deal and another offer isn't made, we expect shares to fall to the pre-offer range of CAD 8 per share.
For a detailed look into the 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."
MEG Energy is engaged in a steam assisted gravity drainage oil sands development at its 80 section Christina Lake Regional Project. As of Dec 31 2010, Co. had total proved bitumen reserves of 605.9 gross thousand barrels (470.5 net thousand barrels).
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