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1 Oil Company to Avoid for Now

Ever since it was spun out of Encana (TSX:ECA)(NYSE:ECA) a few years ago, Cenovus Energy (TSX:CVE)(NYSE:CVE) has been a losing position. The stock price has had a pretty consistent trend over those years, and the trend has been down. So, is this the bottom for this Canadian company, or is it time to pull the plug on this large producer?

Cenovus primarily has operations in the Western Canadian oil sands. In addition to these locations, it also operates a refinery, making it a relatively integrated oil play.

Cenovus has been making strides to improve its operating strength, but is it enough? The full-year 2018 results had some positive developments. Total production from continuing operations increased by 32% over 2017’s results. The company is cheap, trading at 0.9 times book value. It is also sitting close to its all-time-low stock price, so that might draw in some contrarian investors.

Unfortunately, there was a lot of negative news as well. Its 2018 free funds flows decreased 75% over 2017 results. Cash from operating activities decreased by 30% year over year. Much of the decrease was due to events beyond the control of the company, like declining WTI prices, and some were due to realized hedging losses. All in all, the financial results were not exactly encouraging on the whole.

As is the case with many other oil companies, in the years following the collapse in oil prices, Cenovus has had a hard time finding its footing. Its debt levels had become too high during the good times, the lower income levels exacerbating the problem with its leverage. Fortunately, the company has recognized the issue and is actively working to reduce its debt levels through a combination of asset sales and dedicated free funds flows to debt repayments.

In the fourth quarter of 2018 through to January of 2019, Cenovus continued the deleveraging process. During that period, it reduced its total debt by US$1.2 billion, or 16%. This focus on debt repayment is a positive development, but it is preferable for companies to have balance sheets that are less levered from the start.

Cenovus has a yield, but it’s not a compelling reason to hold the shares for a number of reasons. For one thing, the dividend has already been cut in the past few years. This is not uncommon for oil stocks, especially leveraged ones. It was probably a good idea to cut the dividend to conserve funds for operations and debt repayment, but it was disappointing for income investors nonetheless. The yield is currently a paltry 1.63% at current prices.

The bottom line

With its cheap valuation, increasing production, and historically low share price, a contrarian value investor might want to take a stab at this stock. If oil prices increase, Cenovus might benefit substantially. But this stock is not for me. The fact that this commodity stock is a price taker is quite apparent in the year-end results. Like most oil companies, its future hinges on the price of oil, and things aren’t looking that great yet. The dividend has not been secure — another negative for people looking for steady income.

If you are a contrarian investor with a long time horizon and a strong stomach, you might want to take a stab at it. Otherwise, stand aside and avoid this oil producer for now.

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Fool contributor Kris Knutson has no position in any of the stocks mentioned.

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