TSX energy companies will kickstart their Q1 earnings season next week. Once again, the outlook is quite favourable due to the capital discipline and relatively high oil prices. Among the bigwigs, Cenovus Energy (TSX:CVE), the largest TSX energy producer by revenues, will report its Q1 earnings on April 26, 2023. CVE stock has returned 7% in the last 12 months, outperforming its peers. But will we see momentum in 2023, especially driven by its first-quarter earnings?
Should you buy CVE stock?
Cenovus Energy is a $46 billion integrated energy company, whose upstream and downstream segments contribute nearly equally to its top line. It has a large, long-life, low-decline heavy oil reserve base that enables superior financial growth at current prices.
In 2022, it reported free cash flows of $7.7 billion, representing immense 130% growth year-over-year. CVE stock is currently returning 50% of its free cash flows to shareholders.
Many Canadian energy producers are sitting on a cash hoard due to the capital discipline maintained since the pandemic. Higher production and superior oil prices resulted in robust financial growth in the last few years. However, instead of putting excess capital into production, they chose to repay debt and improve leverage positions. This has caused stellar balance sheet improvements not seen in decades.
Solid earnings growth and balance sheet improvement
Cenovus Energy repaid almost $4.4 billion of debt last year. At the end of Q4 2022, it had net debt of $4.2 billion. Thanks to such a rapid debt reduction, its leverage ratio has dropped to 0.7x from over 5x in Q4 2020. As interest expenses will be lower in 2023, profitability should improve. How much debt it repaid in Q1 2023 will be important to see.
In 2023, Cenovus aims to produce 0.82 million barrels of oil equivalent per day, a mere 1.6% growth year over year. While the upstream segment looks well placed to grow this year, the downstream vertical might drag its overall performance in the short to medium term.
It derives 30% of total revenues from its US-based refineries, which operate at much lower margins compared to its Canadian peers. A crucial indicator is that the 3:2:1 crack spread has declined after peaking last year. It is still higher than historical standards, but refiners might not reap as substantial benefits as last year.
The 3:2:1 crack spread is a key profitability indicator that is calculated by subtracting the price of three barrels of crude oil from the price of two barrels of gasoline and one barrel of distillate.
Cenovus intends to allocate 100% of its free cash flows to shareholder returns when its net debt falls below $4 billion. We will get reasonable clarity about when it reaches that target once they report Q1 numbers. CNV currently pays an insignificant dividend that yields 1.7%, way lower than its peers. It has also been slow on the buyback front this year compared to peers.
Investor takeaway
Cenovus shares are currently trading 24% lower than their 52-week highs. The oil price is a key trigger for them. However, financial growth and share repurchases could drive shareholder returns this year.
CVE stock is currently trading at seven times its 2023 earnings and free cash flows. This energy stock seems fairly priced compared to peer TSX energy stocks.
Cenovus Energy looks well-placed when it comes to its upstream earnings growth. The balance sheet improvement is also quite admirable. However, some of its peers are much better placed on the dividend as well as on the valuation front.
