Cenovus Energy Inc. is suffering from a two-year, deal-induced hangover. The oil sands company’s improving fortunes are finally offering a chance to cure its lingering financial headache.
Cenovus, along with a number of Calgary-based rivals, stepped up as buyers in 2017, when a wave of large foreign energy companies decided to exit Alberta. No one matched Cenovus’s spending. The company dropped $17.7-billion to acquire Canadian properties from Houston-based ConocoPhillips Co.
The acquisition was, to put it mildly, poorly received. Cenovus’s stock price tanked, its chief executive departed four months later, Canadian heavy oil prices dropped and the company has struggled ever since to pay down debt and restore its credibility with investors.
The hangover stems from the way Cenovus paid the bill. As part of the purchase price, ConocoPhillips agreed to take 208 million Cenovus shares, plus more than $14-billion in cash. The Texas company said at the time that it would eventually sell the stake, currently worth $2.5-billion.
Cenovus’s stock price has been depressed by the prospect of a massive share sale from ConocoPhillips ever since the deal was announced in March, 2017. A Reuters story last summer saying ConocoPhillips was preparing to offload the holding instantly knocked back Cenovus’s stock price by 7 per cent, although nothing happened.
A number of large stock sales have flopped, as the institutional investors who make or break large transactions showed little interest in adding to their portfolios. Equity offerings this year involving Corus Entertainment Inc., New Gold Inc. and cannabis producer The Green Organic Dutchman Holdings Ltd. all proved difficult to sell, despite being offered at significant discounts to where those stocks were trading at the time.
After two years hard slogging to pay down debt, Cenovus has another way to take out the ConocoPhillips stake: Buy it back.
The company’s peers have shown the way. Right now, investors find little to love in the Canadian oil sands. Alberta oil commands a price well below North American benchmark levels. Pipelines aren’t getting built and the previous Alberta government of Rachel Notley curtailed production. Most Canadian energy stocks trade at historically low valuations, based on metrics such as price to cash flow.
Cenovus’s peers, such as Imperial Oil Ltd., Canadian Natural Resources Ltd. and Suncor Energy Inc., responded to these headwinds by launching massive share-buyback programs. But Cenovus couldn’t contemplate buybacks, as it carried $13-billion of debt coming out of the ConocoPhillips takeover. For the past two years, paying back loans was management’s priority.
The company signalled a shift in strategy when it announced its most recent financial results in late July. Debt is down to $7.1-billion and chief executive Alex Pourbaix said: “As we relentlessly pursue getting our net debt even lower, to $5-billion, our balance-sheet strength positions us to also consider opportunities for increasing shareholder returns and disciplined investments in our business.”
An aggressive buyback program is a low-risk way for Mr. Pourbaix to deliver on the promise of better returns for shareholders, who hold stock that is more than 30 per cent lower than where it traded when Cenovus announced the ConocoPhillips deal. Investment bankers are already pitching the CEO on the concept.
Cenovus churned out $1.6-billion of cash flow from operations in the first six months of the year. Going forward, a significant portion of this money could be earmarked for buying the company’s own shares from investors, including ConocoPhillips. For a sense of just how quickly Cenovus could shrink the Conoco block, consider how aggressively its peers are buying back their own stock.
Imperial Oil threw off $2-billion of cash in the first six months of the year and spent $729-million on buybacks. Exxon Mobil Corp. is one of the Imperial Oil shareholders taking advantage of the program. The U.S. parent constantly raises cash by selling shares, keeping its ownership stake steady at just under 70 per cent of the Canadian company.
Canadian Natural Resources generated $2.9-billion of cash in the first half of the year and bought back $632-million of its own stock. The largest oil sands player, Suncor, churned out $5-billion of cash and plowed $1.1-billion into share repurchases.
With debt now at acceptable levels, Cenovus is in a position to start a buyback program that soaks up $1-billion or more of its own stock annually (the market cap is just under $15-billion today).
By taking part, ConocoPhillips could cash in a significant portion of its holding with minimal market impact. For Mr. Pourbaix, it could be the remedy for a lingering hangover.