Canadian oil and gas stocks saw a steep drawdown recently amid the banking crisis. While bank stocks at large corrected around 13% so far this month, TSX energy stocks mimicked them on looming recession fears.
Canada’s second-biggest energy producer Cenovus Energy (TSX: CVE) was not an exception. It has lost around 15% in the same period, lagging its peers. Since the pandemic crash, the stock has returned nearly 700%.
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What’s next for CVE stock?
It was supposed to be another blockbuster year for the Canadian oil and gas sector in 2023. However, market participants have visibly ignored the fundamentals and seem to have been preparing for an impending severe recession. While the energy demand-supply equation remains skewed, oil prices have halved from last year. The fear seems to be among the leading drivers for energy commodities and stocks lately.
Cenovus Energy aims to produce nearly 820,000 barrels of oil equivalent per day this year. Apart from production, it has significant interests in refining operations as well, with a total capacity of 740,000 barrels per day. For 2023, the company intends to invest $4.2 billion in capital expenditure.
Note that Cenovus Energy has upped its capital expenditure for 2023 by 14% year over year. But the production is estimated to increase only by 1.5% compared to 2022. This has been the trend across the industry mainly due to rising costs. Higher inflation and labour problems is expected to weigh on production this year.
Solid financial growth and deleveraging
TSX energy companies have seen massive financial growth in the last couple of years. Cenovus Energy reported free cash flows of $7.7 billion last year, representing a stellar 116% growth year over year. Although it tripled its dividend last year, it still yields a paltry 2% — way lower than the sector average.
This might change in 2023, given its expected larger allocation of free cash flows for shareholder returns. Cenovus Energy intends to allocate 100% of its free cash flow to buybacks and shareholder payouts when its net debt falls below $4 billion. At the end of the fourth quarter (Q4) of 2022, it had net debt of $4.3 billion. Thanks to its rapid free cash flow growth, CVE has managed to reduce its net debt from $9.6 billion in Q4 2021.
Its debt might increase a little in the current quarter, given its Toledo acquisition. So, we might see a higher portion of its excess cash moving to shareholder returns from Q2 2023.
Oil prices could see a bottom soon. Considering the massive drop in oil prices, the energy cartel OPEC (the Organization of Petroleum Exporting Countries) might intervene and cut production, as it has done in the past. Plus, China is expected to see higher demand after it lifted movement restrictions this year. Moreover, the U.S. government will likely start refilling its Strategic Petroleum Reserve as oil falls below US$70 levels. This could boost demand and provide a floor for oil prices.
Bottom line
On a valuation front, CVE stock is trading six times its free cash flows and seven times its earnings. The stock looks discounted compared to peers. If oil prices revert, Canadian energy companies, including CVE, could see a massive bounce back later this year.
