As Charles Dickens wrote in his classic, A Tale of Two Cities, “It was the best of times, it was the worst of times…” And how right he was. When you’re investing in energy companies, you can wind up feeling so crazed that you just want to tear your hair out. Three years ago, the price of oil was trading over US$110 a barrel, and companies were doing amazing.
Shares of Cenovus Energy Inc. (TSX: CVE)(NYSE: CVE) were trading at over $34.50, and investors were earning a $0.27-per-quarter dividend. Since then, the company has seen its value crater by 73% and its dividend cut to only $0.05 per quarter. And 2017 has been the worst part for the company with shares dropping by 55% year to date.
What is going on?
Oil recently hit a 10-month low of about US$42 a barrel, which makes it increasingly difficult for companies to eke out profits. But oil companies have been trying; significant consolidation has been taking place. Many major oil companies have taken advantage of this glut to increase production by hundreds of thousands of barrels per day.
Unfortunately, Cenovus waited too long to try and get in on the acquisition action. In March, Cenovus announced that it would be acquiring 50% of the FCCL Partnership, which ConocoPhillips owned, for $17.7 billion. On the surface, this deal made sense because it would double Cenovus’s oil sands production and nearly double its bitumen reserves.
The numbers were strong. Full-year numbers in 2018 would have Cenovus producing 515,000 barrels per day across its entire network. Management was projecting that its adjusted funds flow per share would increase by 18%. Further, it was projecting a 16% drop in operating costs per barrel of oil in 2018 and a 26% drop in general and administrative costs per barrel of oil. The argument was simple: Cenovus will pump more oil and pay less per barrel. Win-win, right?
Not so much…
The boost in adjusted funds flow per share is predicated on oil prices at US$55 per barrel. Cut oil prices down to the US$42 low at which the market currently values the commodity, and those adjusted funds flow per share drop precipitously. This is also a problem because the company is looking to sell US$4-5 billion of non-core assets to help fund this acquisition. The problem is, there just aren’t that many buyers with oil where it is. And to make matters worse, buyers know that Cenovus is desperate, so that makes selling assets much harder.
For those sitting on the sidelines, that’s where I’d stay. The oil markets are volatile, and it’s hard to know where things are going to go. Unfortunately for existing investors of Cenovus, there really is no good way out of this other than to just wait. With a lot of the bad news already priced in to the shares, I don’t see much reason why shares will drop much further, though the markets have been known to be irrational from time to time. One option would be to add more shares to your portfolio. This would give you a better yield on cost at 2.22%, and it would help you to average down your position to make breaking even easier.
