(Idea) Cenovus Energy - Q2 Update
This morning, Cenovus Energy (CVE:CA) reported strong second-quarter results. Adjusted funds from operations underperformed analyst expectations by 5%, while production beat expectations by 1%. The share price reacted by selling off 6%, which we believe was attributable to the market-wide selloff rather than to concerns about company fundamentals.
The main highlight for the quarter was that CVE finally reached its $4.0 billion net debt target in July. It is now returning 100% of free cash flow to shareholders through dividends and share repurchases.
Upstream performance was strong all around. Total production came in at approximately 800,000 boe/d, which is in line with the previous quarter. Production over the first six months of the year is trending above management’s full-year guidance range of 790,000 boe/d. The performance caused management to increase its full-year guidance range to between 785,000 and 810,000 boe/d, up 7,500 boe/d at the midpoint of the range. Management expects upstream production to exceed 800,000 boe/d going into 2025. The upstream segment's operating margin was $3.1 billion.
Expansion of CVE’s Christina Lake SAGD project is expected to be completed in mid-2025, while its Foster Creek optimization remains on schedule for completion in 2026. These are the company’s flagship assets that are expected to contribute significantly to production growth over the next few years.
Conventional production increased to 123,000 boe/d, an increase of 2,400 boe/d over the first quarter. The segment saw a material decline in per-barrel operating costs. Offshore segment production was 66,000 boe/d, up 1,300 boe/d over the previous quarter. The West White Rose project is proceeding according to schedule and is expected to commence production in 2026.
Downstream operating results were negatively impacted by a turnaround in the massive Lloydminster upgrader. CVE’s downstream turnarounds are nearing completion, and their successful execution led management to increase its full-year downstream throughput guidance by 5,000 boe/d at the midpoint, to 640,000 boe/d to 670,000 boe/d. Total refinery utilization came in at 93%.
Weak refining margins and unplanned maintenance negatively impacted downstream financial performance. Segment operating margin fell to a negative $153 million.
CVE's Lima and Toledo refineries remained problematic. Both experienced “upsets,” according to management, that led to controlled shutdowns. However, management expects their performance to improve over the coming months. Both refineries are now completing their turnarounds, and it expects the multiple years of effort and capital investment aimed at optimizing the refineries to pay off once they’re back online. Hopefully, the refineries' successful post-turnaround operation, coupled with higher refining margins, will drive a higher downstream segment margin over the coming quarters.
On the capital allocation front, we’re pleased to see management committing all of CVE’s free cash flow after dividends to share repurchases. With CVE’s share trading at a steep discount to our $30 per share intrinsic value estimate for the U.S. listing, we believe this is far and away the best course of action. Days like today present an extraordinary opportunity for repurchases, as the shares traded down 6% while WTI remained in the high-$70s. At these oil prices, CVE generates significant free cash flow that it could allocate toward repurchasing discounted shares.
We should note that the WTI-WCS differential has recently widened relative to the levels seen earlier this year. We suspect the cause is related to refinery outages and maintenance that increased crude oil inventories in Western Canada. We expect the differential to correct back to the $13.50 to $14.50 per barrel range on average until egress is constrained. In the near term, we expect a narrowing of the differential due to crude market tightness, the Trans Mountain pipeline’s ongoing throughput ramp, and increasing throughput out of refineries in the U.S. Midwest. These developments should help to drain Western Canadian oil inventories over the coming months and support higher WCS prices relative to WTI. We expect a narrowing differential to deliver a significant boost to CVE’s cash flow over the coming years.