If oil patch mergers were such a great deal for investors, you would think that oil patch stocks would be on a tear.
The reality of the situation: Canadian energy stocks remain deeply depressed, suggesting that all the chatter about cost savings and buttressed balance sheets are relatively meaningless against a backdrop of weak oil prices and faltering demand for energy.
The latest deal in a continuing period of consolidation appears unlikely to alter this perception.
On Sunday, Cenovus Energy Inc. announced a $3.8-billion stock deal to acquire Husky Energy Inc. (not including debt), winnowing the largest oil and gas producers to Canadian Natural Resources Ltd., Suncor Energy Inc., Imperial Oil Ltd. and Cenovus. But the immediate market reaction was negative.
Cenovus shares fell as much as 14.5 per cent in early trading on Monday. The shares clawed back in later trading, but ended the session down 8.4 per cent on a rough day when the S&P/TSX Composite Index sank 1.4 per cent and the price of crude oil fell more than 3 per cent.
Husky investors did better: The shares surged 12 per cent, owing to a takeover price based on a 21-per-cent premium over Husky’s average share price last week.
But long-term investors had little reason to cheer. Husky shares have fallen 67 per cent in 2020, and they are 80 per cent less than their price five years ago.
The takeover, like many before it in the oil patch, looks more like a demoralized exit than a triumphant fresh start.
No doubt, the deal rests on a few assumptions that can look appealing. By merging operations, the combined companies hope to shed about $1.2-billion in annual costs, starting in the first year after the acquisition is completed (it is expected to close in the first quarter of 2021).
The combined companies will be more diversified across oil production and refining activities, generating smoother cash flows that are not as susceptible to the ups and downs of Canadian oil prices, which can swing wildly. The price of Western Canadian Select oil has traded between roughly US$7 and US$40 a barrel over the past year, settling at US$27.25 a barrel on Monday, down US$2.08.
And in a sector where scale matters, the new Cenovus will generate an estimated 750,000 barrels of oil equivalent a day, big enough to make it the third-largest Canadian oil and gas producer based on output.
But are these selling features enough to make investors giddy about a leaner energy sector?
The consolidation of Canada’s oil patch has been going on for some time now, attracting some investors to the idea that if big players see bargains here, maybe they, too, should be pouncing on beaten up energy stocks.
It hasn’t worked out, though. Over the past three years, the S&P/TSX energy sector has lost about two-thirds of its value, as cheap stocks got cheaper and the touted benefits of scale and cost savings have been steamrolled by weak energy fundamentals.
If all goes well – the global economy recovers and the price of oil rises with steady demand for fossil fuels – then there is a point at which bargain-hunting investors could do well and those cost savings through consolidation will mean something.
But betting on consolidation itself in the hopes that a smaller energy company will get taken out or a bigger energy company will make a savvy deal that will pay off seems like a long shot. Husky is agreeing to a takeover with its share price at depressed levels, suggesting the company saw a bleak future. Why would investors see anything different?
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