Investment overview
Over the past six to 12 months, I have maintained the view oil is likely to trend higher after strong consolidation in the $45 to $50 per barrel range. As the outlook for oil looks promising amid stable economic growth globally, there are stocks trading at very attractive levels.
One name in the oil and gas exploration sector that has the potential to trend higher in the next 12 to 24 months is Cenovus Energy Inc. (CVE, Financial). The stock is 36% lower year to date, but it is important to note it has surged 42% from lows of $6.8 and currently trades around $9.7.
Focusing on some recent developments and their implications, I will elaborate on factors that are likely to keep sentiments bullish for Cenovus Energy for the given investment horizon.
New president and CEO
On Oct. 30, the company announced the appointment of Alex Pourbaix as president and CEO. In my view, this move is likely to be positive for the company.
One of the key focuses for Cenovus in the next few quarters is likely to be disposing of assets to reduce debt. Pourbaix worked for 27 years at TransCanada Corp. (TRP, Financial), where he gained experience in mergers, acquisitions and divestitures. This experience will likely help Cenovus as it cuts assets.
Asset sale
On June 20, Cenovus Energy announced its plan to divest non-core assets with target proceeds of $4 billion to $5 billion in fiscal 2017. The key factor for this divestment is deleveraging after acquiring assets from ConocoPhillips (COP, Financial).
The positive point to note here is the asset divestiture is on track with Cenovus Energy already having announced the sale of its Pelican Lake assets for $1 billion, its Suffield assets for $512 million and its Palliser assets for $1.3 billion.
With further divestitures likely over the next several months, the company is well positioned to meet its target of $4.5 billion in debt reduction by January 2018.
While the asset sales will reduce debt, Cenovus Energy has $4.5 billion in undrawn credit and $0.5 billion in cash. This provides a total liquidity buffer of $5 billion for resilient growth.
Growth assets
It is important to point out that even with asset divestitures, Cenovus Energy is well positioned to exhibit steady production growth in the next three to five years. This is the factor that makes the stock interesting. The divestment of non-core assets only adds to its financial muscles for growth.
In regard to the growth outlook, the following points are likely to trigger positive momentum for Cenovus Energy in the next three to five years:
- The company’s Deep Basin asset in Alberta and British Columbia is likely to deliver production of 240,000 barrels of oil equivalent per day by 2021, which implies production doubling from current levels. With 1,500 net drilling locations already identified for growth, the target seems realistic and will ensure steady growth in cash flow from the asset.
- Pourbaix has already mentioned that maximizing value in oil sands assets is one of his key objectives. Even after the divestiture of non-core assets, Cenovus Energy is positioned to deliver 440,000Â barrels of oil equivalent per day from oil sands (Foster Creek and Christina Lake) over the next five years. This excludes potential production additions at Foster Creek and Narrows Lake phase A project.
- If the two production targets hold true, Cenovus Energy is well positioned to deliver production growth at a compound annual rate of 6% and free cash flow growth at a CAGR of 14% over the next five years. This estimate is at $55 per barrel WTI. I believe that free cash flow will swell as oil trends higher. Importantly, by focusing on key assets, Cenovus Energy is positioned to grow as well as deleverage in the next three to five years.
Conclusion
I strongly believe the company’s acquisition of ConocoPhillips' assets is likely to deliver long-term value. In the near term, Cenovus' credit metrics were strained and management has moved in the right direction by divesting non-core assets.
As the company’s financial flexibility improves over the next six months, I expect reratings by credit agencies will take the stock higher. Further, a clear focus on Deep Basin and oil sands is likely to deliver positive value.
Importantly, I expect oil to maintain positive momentum and free cash flow from key assets will beat expectations and further support deleveraging.
Disclosure: No positions in the stocks discussed.
