Cenovus Energy: Strengthening Oil Market Trumps A Weak Operating Performance
Summary
CVE posted another disappointing quarter.
However, the worst is now behind it, and performance should vastly improve in the second half.
CVE shareholders will benefit from appreciation upside and dividend growth amid higher oil prices.
Cenovus Energy (CVE) announced another disappointing quarter. Adjusted funds flow per share, at $0.71, was slightly below analyst estimates of $0.75. On an unadjusted basis, cash flow was reduced due to a previously announced $1.2 billion cash tax payment and a $300 million payment to acquire the remaining 50% interest in the Toledo Refinery from BP (BP). These cash requirements caused a working capital build that reduced cash flow from operations to negative $286 million.
Net debt ended the quarter at $6.6 billion, $2.6 billion above management’s target for paying out 100% of free cash flow to shareholders. Until net debt is reduced to the $4 billion target, we expect management to prioritize debt paydown. Unfortunately, this will detract from the cash flow available for share repurchases.
Operational performance was also poor. CVE’s upstream segment suffered from lower WTI prices and high WTI-WCS differentials during the quarter. The segment’s poor cash flow performance poor performance caused management to lower its full-year cash flow guidance.
First-quarter production results were reduced by 12,500 bpd as the company built inventories in anticipation of turnarounds in certain of its oil sands assets. This production curtailment and the removal of Terra Nova volumes due to the project's postponement to 2024, caused management to lower CVE’s full-year production forecast range to 790,000 to 810,000 barrels per day (bpd) from 800,000 to 840,000 bpd.
Downstream segment performance during the quarter demonstrated that the process of integrating Husky’s assets continues to proceed more slowly than expected. Since the acquisition in October 2020, CVE has had to upgrade legacy Husky assets, including rebuilding the Superior Refinery after its 2018 explosion, acquiring operatorship and control of its BP Toledo refinery, and making other large capital outlays to integrate the Husky assets with CVE's upstream operation. We look forward to the process being completed in the second half of this year.
In the first quarter, CVE’s Superior and Toledo refineries ran at low throughput rates relative to capacity, which reduced downstream segment margins. The startup process for these refineries has created a temporary drag on cash flow, as crude oil purchases and operating expenses associated with the throughput ramp are accompanied by little revenue. However, both refineries remain on track to be fully up and running in the second quarter and generating free cash flow by July. Once the refineries are fully operational and running near capacity, CVE will reap the full benefit of its integrated business model.
Throughput was also weak at CVE’s non-operated Wood River and Borger refineries due to unplanned outages. The outages, coupled with the slower-than-expected startup of the Toledo refinery, caused the company to reduce its full-year refinery throughput guidance.
On the positive side, CVE increased its quarterly dividend by 33% to CAD$0.14 per share. Also, shareholders won’t be surprised by billion-dollar cash tax payments. Since the company is now cash taxable in all jurisdictions, tax obligations will be less lumpy going forward.
As bad as the quarter was, we’re optimistic that the company’s downstream issues will be resolved by the second half of the year and that its performance will improve significantly from that point.