Cenovus Energy Inc. (
NYSE:CVE) was the first to report Q1 earnings (amongst the Canadian energy peers), and, boy, did it set a high benchmark.
In its Q1 release, CVE announced a clear path forward for capital return back to shareholders. As we've detailed time and time again, at today's oil price, CVE is generating ~C$10 billion in free cash flow. This estimate also underestimates the "real" potential from the recent increase in refining margins. On a 12-month run-rate, we think CVE's free cash flow generation at today's refinery crack spread is closer to ~C$12 billion.
Looking ahead, CVE plans on using 100% of "excess" free cash flow towards share buybacks and variable dividends.
I do want to note a few things here. Note that CVE says opportunistic share repurchase. When you consider share buybacks, it is meaningless to buy back for the sake of buying back. You have to buy the shares below the intrinsic value. By setting a conservative value for the intrinsic value, you can reliably grow shareholder value over time. We are very happy to see that CVE will be very disciplined on this front (intrinsic value using $60/bbl WTI).
In addition, the introduction of a variable dividend is highly welcomed, as CVE doesn't hedge any of its production, so investors can "bet/invest" based on their view of where oil prices are headed. The integrated structure also offers investors an incentive to buy CVE, as it captures the refining margin upside as well (which should translate into a higher variable dividend).
By our estimate, CVE should have practically no debt by year-end. We think for the purpose of maximizing the capital structure, CVE is opting to use C$4 billion as the threshold for the most "optimal" capital structure. As a result, we estimate an excess of ~C$4 billion will have to be used towards share buybacks or a variable dividend.
Assuming the shares stay here, this will translate into either of the following:
- 168.56 million shares
- ~C$2.07 variable dividend
We hope that CVE uses the excess towards mostly share buybacks and a portion into a variable dividend, but this is contingent on the shares staying cheap.
Technically speaking, CVE has broken out on the bullish shareholder plan announcement. We are looking for a move to $28 USD in the coming months.
At $105/bbl WTI (and not assuming an increase in refining margin), we see CVE trading at C$63.78 or $50 USD per share.
Given how oil market fundamentals are trending, we think the odds of refining margins structurally staying higher are increasing, thus further boosting the valuation for CVE.
For the first time in a long time, we are thinking that this model is not doing fair justice to CVE's "implied" valuation given the combination of higher potential margins and the more aggressive share buyback plan.
But first things first, this is a great 1st world problem to encounter.
Conclusion
Buy CVE, it's going higher.
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