Digging Into Cenovus Energy

By Chris Dumont | October 17, 2011 AAA

With the volatility of oil prices this year, caused by a variety of macroeconomic factors, Cenovus Energy (NYSE:CVE) seems poised to take the lead in terms of both production and profits. However, is Cenovus worth investing in? Let's take a look at its oil sands operations, in particular, as this is their core strength.

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Background
Based out of Calgary, Alberta, Cenovus Energy is a Canadian oil company. Originally spun off by Encana in November 2009, Cenovus specializes in oil sands and natural gas in Alberta and southern Saskatchewan, along with interests in two refineries in the U.S.. During the first half of 2011, Cenovus produced over 129,500 barrels per day and had natural gas production of over 650 MMcf/d. By the end of 2021 the company's goal is to hit 500,000 barrels per day, a staggering 286% increase. With revenues of almost $13 billion in 2010 and one of the lowest production cost profiles out of its oil sands rivals, Cenovus is certainly an interesting play. (Find out how to invest and protect your investments in this slippery sector. For more, see Peak Oil: What To Do When The Wells Run Dry.)

Strengths
Low Cost
Cenovus has one of the lowest costs in the industry. Not only that, but they use their own natural gas production to assist in their steam assisted gravity drainage technology (SAGD). About 110 MMcf/d of natural gas is used in their operations, almost 17% of their natural gas production. This helped them in having a cost per barrel of $13.24, for the second quarter of 2011, at their Foster Creek and Christina Lake operations. To put this in perspective, Suncor (NYSE:SU) has an average cost per barrel of $51, as of the second quarter of 2011, due to lower production volumes than normal (their forecast is an average of $39 to $43 per barrel for 2011 still much higher than Cenovus). (For related reading, see Oil: A Big Investment With Big Tax Breaks.)

Growth
Cenovus has stated that its focus in the next five years will be to increase its crude oil production, primarily from Foster Creek, Christina Lake and Pelican Lake. Together for the first six months of 2011, these projects account for an average of 82,905 barrels per day, 64% of its total oil production of 129,500 bpd, with its conventional oil production consisting of the rest. With a goal of 500,000 bpd by 2021 of total oil production, Cenovus is certainly aiming high.

Taking a look at the growth potential of these three key projects we can see why. Foster Creek & Christina Lake together are averaging 62,517 barrels per day for 2011; Cenovus has a target of 218,000 bpd by 2013, an increase of 249%. Meanwhile, Pelican Lake is averaging 20,388 bpd for 2011, with a target of 55,000 bpd by 2016, a growth of 170%.

To put this in perspective, Suncor has stated its goal is to boost production by 8% per year from 500,000 bpd to 1 million by 2020, a 100% gain. Cenovus plans to go from 129,500 to 500,000 bpd, a 286% increase, in roughly the same time period.

Dividends
Cenovus currently pays a generous 2.3% dividend yield against its peer. Suncor yields 1.5%, Canadian Natural Resources yields 1.1% and Imperial Oil yields 1.1%.

Financial Analysis
With revenue for the first six months of 2011 of $7.5 billion, up 19% from the first six months of 2010, operating earnings of $604 million, up nearly 22%, and free cash flow of $443 million, up 37% from $323 million, Cenovus proves it can make money. It is important to note that Cenovus increased its capital expenditures $371 million, compared to the first six months of 2010, and yet still showed a 37% increase in free cash flow, due in part to the strength of its two refineries. (For more on free cash flow, see Free Cash Flow: Free, But Not Always Easy.)

Now let's take a look at some of the common multiples used to valuate oil companies:

Company P/E Forward P/E EV/EBITDA (ttm) EV/BOE/d* Price/Cash Flow Price/Book Value
Cenovus (NYSE:CVE) 26.7 15.3 11.1 $133,960 $9.77 3.02
Suncor (NYSE:SU) 11.9 8.4 6.6 $120,500 $5.66 1.31
Canadian Natural Resources (NYSE:CNQ) 27.0 8.7 7.1 $79,635 $5.98 1.69
Imperial Oil (NYSE:IMO) 12.6 11.8 8.2 $118,938 $9.47 2.77

*All BOE/d numbers based on second quarter 2011 results. Also referred to as price per flowing barrel.

Taking a look at these multiples we can see that Cenovus is certainly not cheap. Against its peers it is tied for the highest P/E ratio, meaning its share price is relatively expensive against its earnings per share. Looking at the forward P/E is a little better, factoring in its high growth plans, however again it has the highest multiple out of the oil sand providers. It seems like investors have realized Cenovus has the cost advantage and growth on their side, and are definitely paying for it.

Now looking at the rest of the multiples, Cenovus has an enterprise value over EBITDA, also known as the enterprise multiple, of 11.1 which is again the highest (lower is better, indicating a stock could be undervalued). Its price per flowing barrel is the highest at $133,960 per barrel, an 11% premium to Suncor at $120,500 per boe. Its share price over its operating cash flow is also the highest, commanding a 73% premium over Suncor. It's price per book value is the highest, as well.

What does this mean to investors? It means that as of right now Cenovus is certainly not a value stock. Though with time the multiples should decrease, with their substantial production increases, and they do still have the highest dividend yield at 2.3% out of the others. (For more information on the enterprise multiple, see Value Investing Using the Enterprise Multiple.)

Risks
As with any company there are risks to consider, as well. As oil is priced in U.S. dollars, having the Canadian dollar increase in value has a negative effect on Cenovus's top line. Though it is important to note that typically when the price of oil increases, the Canadian dollar follows. Between 2006-2009 the correlation between the Canadian dollar and the price of oil was 80%. On a positive note the higher the price of oil, the more money Cenovus makes.

Other risk considerations for the industry include possible environmental regulations and a the possible global recession, however these are more influential as future considerations, than as immediate concerns.

The Bottom Line
By 2021, Cenovus plans to grow its production by 286% to 500,000 bpd. It has top quality projects with its Foster Creek, Christina Lake and Pelican Lake developments. Not only that but it has three emerging projects, Narrow Lakes, Grand Rapids and Telephone Lake that will help contribute to its overall goal. It pays the highest dividend yield out of its oil sand peers and has the lowest production cost, however, its multiples make it look expensive, and right now it certainly isn't qualified to be a value stock. This doesn't leave much room for a margin of safety, but if you believe oil prices are heading higher and you're looking for an oil sands play with growth and a decent dividend yield, Cenovus might be worth a closer look. (For more on value investing, see The Value Investor's Handbook.)

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