Oil Sand Operators Have Significant Upside
Note: Dollar references are to Canadian dollars unless otherwise specified.
With the recent oil selloff, we wanted to review the potential upside of our favorite oil sands operators, Athabasca Oil (ATH:CA) (OTCPK:ATHOF), MEG Energy (MEG:CA) (OTCPK:MEGEF), Cenovus Energy (CVE:CA) (CVE), and Suncor Energy (SU:CA) (SU). While the physical market has weakened over the past month, prices have undershot levels justified by fundamentals. We expect a favorable outcome at the OPEC meeting to send WTI back into the US$80s per barrel, at which point these stocks offer significant fundamental upside.
Athabasca Oil
ATH stock has been one of the best performers year-to-date among Canadian E&Ps, with its shares up 75.1%. The stock has stayed strong over recent weeks despite falling oil prices and a widening WTI-WCS differential.
ATH’s torque to higher oil prices makes it a good choice for aggressive investors who believe oil prices will be sustained above $80 per barrel over the coming years. However, its stock’s outperformance this year reduces its appeal relative to the other oil sands operators. ATH shares offer 64.3% appreciation potential at US$85 per barrel WTI and a 12% free cash flow yield.
ATH has by far the longest reserve life of all the oil sands E&Ps, which makes it more valuable from a free cash flow yield and discounted cash flow perspective. ATH also benefits from its lack of leverge, as it aggressively allocated free cash flow to repay debt amid high oil prices in 2022. A non-core disposition of light-oil production for $160 million in the third quarter also furthered its pace of debt reduction.
In April, ATH reached its net debt target and, since then, has allocated more than 75% of its free cash flow to share repurchases. The shift from debt reduction to repurchases is shown in the table below in the areas highlighted in yellow.
Management has guided to $1 billion of free cash flow from 2023 through 2025, which it intends to allocate primarily to share repurchases.
ATH’s small size, long reserve life, and conservative balance sheet make it more likely to be an acquisition candidate, as even a large peer with a 30 or 40-year reserve life can extend its reserve life by acquiring ATH.
The downside for ATH shares have been its relatively high exposure to the WTI-WCS differential. Relatively high costs per barrel due to its smaller size and scale are also a negative. Inventive-based compensation is so high as to be egregious, though it has the benefit of maximizing management’s incentive to perform for shareholders.
Longer-term, the company will benefit from the expansion of its Leismer asset. It plans to increase Leismer’s production base from 28,000 barrels per day (bpd) expected in 2024 to 40,000 bpd, though doing so will entail significant capex. The additional production will grow companywide output by more than one-third.
If oil prices stay high, ATH is likely to refrain from retiring its remaining long-term debt due to repayment penalties that are in place until Q4 of 2024. As a result, the company’s massive cash flow may require it to adopt a Substantial Issuer Bid, as opposed to a Normal-Course Issuer Bid, to facilitate repurchases.