I’ve said it before and I’ll say it again. Trying to pick the bottom of this bear market in crude is a sucker’s game.
When oil flirted with $110 per barrel in the summer, there was nobody willing to stick their neck out and call the commodity overvalued. It wasn’t until oil got to $80 per barrel before predictions started coming in that oil could go much lower, and even then, there were plenty of analysts who thought crude would march back higher again.
In short, everyone who tries to predict the price of crude is just guessing.
I strongly urge investors to focus on what they can control—namely, looking for cheap opportunities in the sector. There are dozens of beaten-up energy names that are likely to move up once oil shakes off the $50 handle and goes higher. All we really need to do is find a producer with a great balance sheet, just in case the recovery in crude takes longer than we all think.
Two obvious choices for investors are Husky Energy Inc. (TSX:HSE) and Cenovus Energy Inc. (TSX:CVE)(NYSE:CVE), two giants in the oil sands. Are either of these companies a good choice for playing the recovery in the price of crude? Let’s take a closer look at each.
Balance sheet strength
Even though both companies are currently financing expansions of their oil sands operations, each have done a nice job keeping debt in check.
Let’s start with Husky. Although the company’s debt has ticked up lately—increasing from $4.1 billion to $5.2 billion since the end of June’s quarter—the company is still in a good financial position. It currently boasts more than $1.2 billion in cash, and it has total assets of more than $38 billion. Although that looks to be a pretty solid balance sheet, the company has announced plans to sell up to $3 billion in new shares, mostly to fund its oil sands expansion.
Compared to Husky, Cenovus’s balance sheet isn’t quite as good. The company also has about $5 billion in debt, although it’s only offset by a little more than $800 million in cash. But Cenovus only has $28 billion in assets, putting it at a much higher debt-to-assets ratio.
The company’s management also must have felt a little concerned with the debt level, since it recently raised $1.5 billion by issuing shares. According to news reports surrounding the bought deal, the appetite for these shares was tepid at best. Still, the extra $1.5 billion will nicely shore up the balance sheet.
An important part of buying into turnaround stories is getting paid to wait. Both companies are offering dividend yields of more than 4%, but are they sustainable?
Part of the reason why both companies are raising cash by issuing shares is because of debt covenant issues. When debt reaches a certain multiple of cash flow, debt holders can force management to stop paying shareholders a dividend to free up money for interest. This is obviously bad news for shareholders who enjoy those generous dividends.
In the short term, dividends for both these energy giants look to be secure. They have ample capital to continue capital expenditures, while generating enough cash to cover the dividends. However, if oil doesn’t recover by the end of 2015, speculation about dividend cuts will likely begin.
As the weaker of the two companies, Cenovus most likely has the greater upside potential when oil recovers.
Investors are a little more concerned with Cenovus’s long-term future than with Husky’s. That’s because Husky is the more integrated operator, and is offsetting the weakness in crude with improvements in its refining business. Cenovus is more tied to the price of oil than Husky.
Cenovus shares are down nearly 50% since peaking in June, while Husky’s shares have only shed 25%. But with that potential upside comes more volatility, since it’s obvious Husky will weather the storm better if this decline lasts for years.
In the end, it comes down to risk. Cenovus should have better upside potential when crude finally recovers, but Husky has the better balance sheet and solid downstream earnings. Either way, I don’t think you can go wrong owning either of these energy giants in the long term.
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Fool contributor Nelson Smith has no position in any stocks mentioned.