Cenovus Energy CVE
December 21, 2009 - 5:28pm EST by
2009 2010
Price: 24.03 EPS $1.56 $1.63
Shares Out. (in M): 751 P/E 15.4x 14.7x
Market Cap (in $M): 18,053 P/FCF NM NM
Net Debt (in $M): 2,307 EBIT 0 0
TEV ($): 20,360 TEV/EBIT NM NM

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If you are looking for a way to invest in a well-run company of size that will benefit from higher oil prices over the longer term, then you should learn more about Cenovus Energy (CVE). 

Cenovus consists of what were the integrated oil assets of Canada's EnCana Corporation.  By way of background, EnCana originally announced its intention to split its oil and gas businesses in May 2008.  The plan was to create two independent, publicly-traded energy companies.  EnCana would be the pure-play natural gas company focused on development of unconventional resources in North America with a diversified portfolio of shale and other gas resource plays in key basins stretching from northeast British Columbia to Louisiana.  Cenovus would consist of EnCana's integrated oil business, which includes enhanced oil projects, refining assets, and conventional oil and gas assets in Alberta and Saskatchewan.  For those of you familiar with the old EnCana, these businesses were reported by EnCana as the Integrated Oil Division and the Canadian Plains Division.  Cenovus would contain 1/3 of EnCana's reserves and production, with EnCana holding onto the remaining 2/3.

However, EnCana's plans were delayed due to deterioration in credit markets and the general economy.  Fortunately, improving conditions enabled EnCana to resume the process this year.  On November 25 shareholders voted to move ahead with the spin.  EnCana shareholders retained their original EnCana shares and received one Cenovus share for every EnCana share held.  Cenovus began trading on the NYSE in early December.

The investment idea is based on the premise that Cenovus will produce superior, sustainable growth from enhanced oil operations anchored by stable production and cash flow from oil and gas resource plays.  The Canadian Plains assets are expected to provide a strong, predictable production base and free cash flow to fund growth internally.  The Canadian Plains assets include the southern Alberta shallow gas play along with the Pelican Lake heavy oil and Weyburn medium oil fields.  The division can be thought of as having a low-risk profile.  It should generate predictable free cash flow.  Although the shallow gas play is a declining asset, its cash flow will be used to fund the oil sands projects.

The primary growth opportunities at Cenovus are the various developments of bitumen production at Foster Creek, Christina Lake, and the other emerging heavy-oil and bitumen resource plays.  Foster Creek and Christina Lake is part of a 50/50 JV partnership with ConocoPhillips, which also includes the Wood River and Borger refineries in Illinois and Texas.  For those who are less familiar with oil sands properties, both Foster Creek and Christina Lake are generally viewed as best-in-class SAGD (steam assisted gravity drainage) projects that have low steam-oil ratios and high average well production rates.  Production at Foster Creek and Christina Lake had a 20% CAGR from 2006 to 2009, and the company is targeting 10-15% going forward.  Cenovus has a record of more than 10 years of demonstrated growth as a leading SAGD operator.  The downstream portion of Cenovus's business is operated by COP.  Integration of the upstream heavy oil and bitumen production allows the company to capture the full oil sands value chain (bitumen production through to supply of refined products). 

Cenovus possesses very high quality oil sands leases with no mining exposure and a track record as an industry leader in technical proficiency and cost controls.  Cenovus has 8.1 million net acres, 1.2 billion BOE of proved reserves, 248 MBOE/d of estimated production in 2009, and 226 Mbbls/d refining capacity.  While production is 55% natural gas currently, reserves are 75% oil.  So this company will become an "oilier" bet as time elapses. 

Management has a first rate reputation and will now be able to focus exclusively on Cenovus.  Importantly, the transition to a standalone enterprise should go smoothly because the leadership teams and divisional structures have been in place since May 2008.  President and CEO Brain Ferguson is the former CFO of EnCana.  Ferguson joined EnCana's predecessor company, Alberta Energy, in 1984 after working as an accountant for four years.  He has run EnCana's Corporate Development group.  CFO Ivor Ruste joined EnCana in 2006 and most recently served as EVP of Corporate Responsibility and Chief Risk Officer.  He previously worked at KPMG.  The EVP of Enhanced Oil Development & New Resource Plays is Harbir Chhina, who leads the development of Cenovus' oil sands resource base.  He is recognized as one of the leaders of Canada's oil sands development.  He worked at the Alberta Oil Sands Technology and Research Authority from 1982 to 1988 and in the 1990s worked on over 20 different pilots, including the original Foster Creek pilot at the Alberta Energy Company (the predecessor of EnCana). 

Cenovus has a strong balance sheet.  At the end of Q3, it had pro forma debt/capital of 24%, giving it one of the lowest leverage ratios of comparable companies.  In addition, it has established a $2.5 billion credit facility.  The company intends to retain EnCana's original target capital structure, with debt/capital of less than 40% and debt/EBITDA of less than 2x.  According to the latest company presentation, Cenovus is targeting a 3-4% dividend yield

The risks include cash flow exposure to commodity price fluctuations as well as exposure to foreign exchange rates between the Canadian and US dollars.  In addition, Cenovus has risks related to weather interruptions, dry holes, unplanned shutdowns and production delays, and cost over-runs.  The company could also face unanticipated increases in decline rates, which would lower production volumes and cash flow.

It is reasonable to look at sum-of-the-parts analysis for Cenovus.  Most analysts are just now putting out research reports, and most indicate that the NAV is above $30 per share assuming $75-80/bbl for WTI.  On a cash flow multiples basis, Cenovus shares are trading at 7.4x 2010 EV/DACF, which is in line with or slightly lower than other integrated oil peers despite Cenovus' superior asset base described above.


Higher oil prices

Spin-off dynamics playing out; more visibility to standalone shares

Operational success in developing oil sands growth projects

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