Cenovus Energy Inc. (NYSE:CVE) Q1 2024 Earnings Call Transcript

Cenovus Energy Inc. (NYSE:CVE) Q1 2024 Earnings Call Transcript May 1, 2024

Cenovus Energy Inc. beats earnings expectations. Reported EPS is $0.46, expectations were $0.35. Cenovus Energy Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day ladies and gentlemen and thank you for standing by. Welcome to Cenovus Energy’s First Quarter Results. As a reminder, today’s call is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] Please be advised that this conference call may not be recorded or rebroadcast without the express consent of Cenovus Energy. I would now like to turn the conference call over to Mr. Jason Abbate, Senior Vice President, Investor Relations. Please go ahead, Mr. Abbate.

Jason Abbate: Thank you, operator. Good morning everyone and welcome to Cenovus’ 2024 first quarter results conference call. On the call this morning, our CEO, Jon McKenzie, will take you through our results. Then we’ll open the line for Jon and members of the Cenovus management team to take your questions. Before getting started, I refer you to our advisories located at the end of today’s news release. These describe the forward-looking information, non-GAAP measures and oil and gas terms referred to today. They also outline the risk factors and assumptions relevant to this discussion. Additional information is available in Cenovus’ annual MD&A and our most recent AIF and Form 40-F. All figures are presented in Canadian dollars and before royalties unless otherwise stated.

You can view our results on our website at cenovus.com. I’d ask that you keep the one question with a maximum of one follow-up. You’re welcome to rejoin the queue for any other follow-up questions you may have. Jon, please go ahead.

Jon McKenzie: Great and thank you very much, Jason and good morning everybody. Safety is at the forefront of everything we do at Cenovus, and I’d like to take a moment to acknowledge an important accomplishment in the first quarter. In our Atlantic region, we safely and successfully took the SeaRose FPSO off station, which is a once in 10 year or more activity, a job well done by everybody involved. Now, at our Investor Day, we outlined our strategic objectives, the low-cost organic growth opportunities with our high-quality assets and how we’ll leverage our integrated value chain. We also talked about our disciplined financial framework, which includes growing shareholder returns. Our first quarter results are a reflection of our disciplined approach to managing this business.

We continue to be pleased with the performance of our upstream business while driving focused improvement in downstream operations and increasing margin capture with the quarter achieving the highest throughput to-date. Our upstream business delivered strong operating results in line with the prior quarter with production of around 800,000 barrels equivalent per day. This was slightly lower than Q4 with planned maintenance having started at the SeaRose FPSO. I’d like to highlight that the Lloydminster thermals produced over 114,000 barrels per day the highest quarterly average in the history of the asset, reflecting higher operating efficiency and improved downhole pump reliability. Our oil sands and thermal assets continue to produce exceptional results.

We remain on track to deliver future production growth from Narrows Lake tieback to Christina Lake. The pipeline is now 67% constructed with hydro testing in line and plan to be completed by the end of the year. And at Foster Creek optimization project, this is on schedule for our targeted 2026 start-up. We’ll also be starting up two additional well pads at Sunrise later this year, supporting the base production and the start of production growth in 2025. We also continue to optimize our turnaround schedule. And as such, we have advanced some of the work out of our planned Q3 turnaround at Christina Lake into Q2. The impact of our planned outages can be found in the maintenance table in the news release. We’re also looking forward to the important milestone for our industry with the imminent startup of the TMX pipeline.

This critical piece of — with this critical piece of infrastructure now complete, we anticipate light-heavy differentials will remain narrow for years, while excess egress capacity exists. And in our conventional gas business, production volumes remained relatively consistent around 121,000 BOE per day. And as a reminder, we test all opportunities at the bottom of the pricing cycle and we continue to progress our capital program with a focus on safe execution and cost reductions. First quarter production in our offshore business segments remained steady at approximately 65,000 BOE per day. The Asia-Pacific assets continued to operate reliably generating about CAD263 million of operating margin. In the Atlantic region, turnover returned to production and contributed about 7,200 barrels per day in the first quarter.

The SeaRose FPSO is a dry dock with regulatory maintenance work progressing as planned in preparation for the startup of the West White Rose project in 2026. Now, as we previously communicated, we anticipate the SeaRose will return to production late in the third quarter of 2024. The progression of the White Rose project continues as planned and is now approximately 80% complete. Overall, our capital spend remains on track for this project. In the first quarter, the company spent just over CAD1 billion in capital, and we expect to be well within our guidance range for total capital spend this year. It was another strong quarter for upstream business, and we look forward to continuing to execute our plans as the year progresses. Now, moving to our downstream segment.

In our Canadian refining business, average utilization for the first quarter was about 94%. Our refining and upgrading assets continued to perform very well with high reliability. That said, the refining margin contribution from the Canadian refining segment was impacted by the decline in synthetic crude prices over the quarter and narrow heavy oil differentials in March. In the next few weeks, we’ll be executing a large-scale turnaround at the Lloydminster upgrader that is expected to reduce Q2 throughput by about 45,000 barrels per day for the quarter. This has already been reflected in our corporate guidance for the year. In the U.S. refining segment, combined crude utilization across the assets was 87%, an increase from the prior quarter.

This was primarily driven by lower levels of planned maintenance at our non-operated refineries and improved operating performance across the refining portfolio. The weak Chicago crack environment in the fourth quarter of 2023 was a challenge for our U.S. business that carried into January of 2024. With product inventories rebalancing in the PADD II market, we’ve seen a strong rebound in the Chicago crack spread, which we were able to take advantage with all of our refineries operationally available and running well. This resulted in a meaningful improvement to our U.S. refining margins exiting the first quarter. We anticipate the Chicago crack environment to remain relatively strong with heavy industry turnaround schedule underway and seasonal demand strengthening.

Overall, we had the highest quarterly throughput for our downstream business since the acquisition of our operated refining assets in 2021, demonstrating the continued progress of our plans to improve the reliability profitability and utilization of the business. Now, to our corporate and financial performance. Cenovus generated CAD3.2 billion of operating margin in the first quarter, approximately CAD2.2 billion of adjusted funds flow and CAD1.2 billion of free funds flow which reflects higher refining benchmark prices and about CAD195 million FIFO gain in the U.S. Refining segment that was offset by about CAD250 million for share-based compensation paid in the first quarter. Through our base dividend, we returned CAD262 million to shareholders and the Board of Directors also approved an increase to the quarterly base dividend of 29% to CAD0.72 per share annually, consistent with the company’s commitment to grow shareholder returns.

In alignment with our shareholder returns framework, we returned CAD165 million to shareholders through our share buyback program in Q1, and the Board of Directors declared a variable dividend of CAD251 million, fulfilling our commitment of 50% of excess free funds flow returned to shareholders. Now, subsequent to the end of the quarter, from April 1st to April 26th, the company repurchased approximately CAD250 million worth of shares through our NCIB or about 8.6 million shares. The company’s net debt was approximately CAD4.8 billion at the end of the first quarter, a reduction of CAD233 million from year-end and included a CAD370 million build in non-cash working capital. And this was largely a function of benchmark pricing improvements and steady operations across the value chains.

Since we set our 2024 budget in December, commodity prices have exceeded our expectations and based on the current commodity price complex and our operating plan, we expect to achieve our net debt target at some point in the summer of 2024. As we described in the first quarter news release, we’re also introducing some minor changes to our shareholder returns framework. Once we achieve our net debt threshold, we’ll be targeting — we will target allocating 100% and of each subsequent quarter’s excess free funds flow to shareholder returns. This remains unchanged from our current approach. In the event that net debt exceeds CAD4 billion at a given quarter’s end, we will reduce the 100% target allocation of excess refunds flow by the amount that net debt exceeded CAD4 billion.

In order to efficiently manage working capital and cash, the allocation of excess free funds flow to shareholder returns may be accelerated, deferred, or reallocated between quarters, while maintaining our target to allocate 100% of excess free funds flow over time to shareholder returns and sustained net debt at CAD4 billion. This new framework will become effective once we reach CAD4 billion net debt target and until then, there will be no change to the current target allocation of 50% of excess free funds flow to shareholder returns and 50% of excess refunds flow to deleveraging the balance sheet. Ultimately, the goal of the revised framework is to improve flexibility while continuing to strive towards paying 100% shareholder returns over time and sustain net debt of CAD4 billion.

Now, before closing, I’m pleased to share that during the quarter of — first quarter of 2024, the company received a credit rating upgraded from S&P Global to BBB with a stable outlook. With this target achieved, we have received mid-BBB ratings from all rating agencies. As we said at our Investor Day, we’re focused on achieving our CAD4 billion net debt target, progressing our high-return growth projects in the upstream and continuing to run the downstream business reliably, profitably and safely showing improvements quarter-over-quarter. And with that, I think we’re all ready to answer your questions.

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Q&A Session

Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Greg Pardy from RBC Capital Markets. Please go ahead.

Greg Pardy: Yes, thanks. Good morning. And Jon and team, thanks very much for the run down.

Jon McKenzie: Thanks Greg.

Greg Pardy: Yes, well, they that’s a complement. It’s a good way to start a call off. So, let’s start maybe just with the share price range you guys have talked about in the past. I believe the upper bound was around 30%, where variables became more attractive and buybacks were less attractive. Could you revisit that? I’m just curious maybe what that range looks like? And then presumably, that upper bound number is going to rise with time.

Kam Sandhar: Morning Greg, it’s Kam. First off, I’m just going to say that the number that you’re referencing, I would say, was purely used as an illustrative measure to describe what our framework is. It is not a ceiling. In fact, I would say, as Jon pointed out on the call, we bought back 250 million shares here over the last month. So, we still see a lot of attractive return to continue to buy back shares, and you’ll continue to see us active in the market, as I mentioned in April. So, the principles around that framework has not changed. I would say we still have lots of room to continue on the plan that we have. The variable payment that we made through Q1 is really a reflection of the very formulaic approach that we took to our framework that we’ve outlined previously in that if we under allocate that we would pay out the remainder through a variable.

So, it is not a reflection of any kind of ceiling on the share price. I would say it’s a reflection of us sticking to the commitment that we made on the framework. So — and as Jon described, going forward, we are going to give ourselves some flexibility if we do end up over under-allocating that we will look at either buying shares or looking at a variable dividend. But today, still lots of opportunity to continue to repurchase shares.

Jon McKenzie: Yes, Greg, and I would just add on to that, please don’t read into the fact that we’ve got a variable dividend as any kind of view that we take internally on the intrinsic value of the stock. One of the things that we have to do on a quarter-over-quarter basis is allocate excess free cash flow as it arrives to shareholder returns. And you’ll note in the quarter that cracks in Chicago were actually quite depressed. And in fact, gasoline cracks were negative in January. All of that changed in February and March, and you’re kind of in a window where you have to make some estimates about how much excess free cash flow you’re going to have in a very volatile commodity market. In Q4 of 2023, we underestimated — or we overestimated the amount of excess free cash flow we were going to have.

And I think in this quarter, we are probably on the other end of it. But that shouldn’t be — or nobody should take that as a reflection about how we feel what the intrinsic value of the shares.

Greg Pardy: Okay, that’s actually really helpful to clarify. So, I’m going to completely shift gears maybe on the TMX. Just curious, could you bring us up to speed maybe with where you stand in the marketing process. So, have you fulfilled your line fill, have you got tankers kind of set to go? Do you expect to make sales or record sales in the second quarter? And that’s from me. Thanks.

Drew Zieglgansberger: Yes, good morning Greg, it’s Drew. Simple answer is yes to all your questions. So, this is a really good day for Canada. TMX came out this morning and they are officially on commencement. So, I think this has been a long way today for everybody. So, we’re pretty excited on behalf of the industry and Canada to have another great asset available to us. So, to your question, we have been preparing for this for quite some time. Our last component of the very small volume of final line fill is going here now this month, and it’s about 1.3 million barrels of our share. And so over the last quarter and then finishing this quarter, that full fill from our share is going to be in place. Our teams have been working with buyers.

There’s a pretty vast market out there, which is exciting. And yes, we are preparing to start to ship and we expect the operation to commence here in May. And as we’ve talked about the last few quarters, we are expecting it to be a bit bumpy as things get up to good stable state so we are anticipating a little bit of bumpiness, but the teams are taking that into account. But it’s a great day to start using the asset.

Greg Pardy: Terrific. Thanks very much.

Jon McKenzie: Thanks Greg.

Operator: Thank you. And your next question comes from the line of Dennis Fong from CIBC. Please go ahead.

Dennis Fong: Hi, good morning and thanks for taking my questions. Maybe the first one here is just related to superior. Can we get maybe an update in terms of the ramp-up of the facility as well as how you guys are thinking about the cadence of the de-inventory event at Superior as well?

Keith Chiasson: Hey Dennis, it’s Keith here. Things are progressing as per our plan. We talked about last quarter, taking kind of the first six months to the inventory from kind of up and down starts in 2023 and the inventory that we built up. All the kit is running well, and we’re progressing on that the inventory plan. So, kind of around midyear, we will then — the only last remaining item to restart as the HFO key at Superior, which will start in early Q3. And that will have all of the asset running. But even before that, we should see our crude rate through that asset increase to near full capacity. So, things are progressing as per plan. The market is constructive to de-inventory and mechanically, the refinery is running all the units with the exception of the HFO key at this point.

Dennis Fong: Great. I appreciate that color and context. Maybe staying with the downstream and maybe a little bit of a follow-on to the entire TMX situation. Obviously, as disk [ph] narrow, some of the feedstock costs to increase with respect to the refining operations. Can you talk towards some of the initiatives that you touched on a little bit at the Investor Day and maybe where that could go looking forward in terms of improving realizations on refined product and strengthening margin just again, now that you’re operating all three of those refineries?

Jon McKenzie: Sure. Well, maybe I’ll start there, Dennis. I mean there’s three real levers to refining economics and the first and the biggest is getting the best and the right and the cheapest feedstock into your refineries. So, as you know, the refineries that we own and operate are typically heavy oil refineries. And those heavy oil differentials narrowing will be a negative for the refineries by and large. The offset obviously comes in our — or upstream, sorry, where we realize the value of that. And that was always part of the integrated model. So, for example, when we take the upgrade or down for turnaround this quarter, we’re doing that at a time of very low differentials. So, the economic impact of that is actually quite muted as we take most of that diluted bitumen to market.

The other big area that we continue to work on is the placement of products, and we continue to push farther and farther into the eastern block of PADD II. We see that as a highly prospective area. And then ultimately, as we’ve talked about getting product into PADD I and its Canada is just something that we are actively looking to explore and do through time. Third area that we’re looking at is our cost control and making sure that we have minimized our capital and operating costs in the refineries. Reliability today takes precedent over really trying to grind out the last nickel of our operating cost, but it’s something that we continue to look at on a day-to-day basis. So, as we kind of go forward, what you should see from us are increasingly better levels of reliability across our refining fleet through time and better profitability that comes with that as we optimize the commercial part of the operation over the top of that.

The key for us really is the reliability that allows that commercial optimization to happen through time. And I think Q1 is probably the start of something that we see a strong continuing trend going forward.

Dennis Fong: Great. Appreciate the color there. I can turn it back. Thanks.

Operator: Thank you. [Operator Instructions] And your next question comes from the line of Menno Hulshof from TD Cowen. Please go ahead.

Menno Hulshof: Thanks and good morning everyone. I’ll start with a follow-up question to Greg’s question on TMX. Where do things stand in terms of ongoing toll discussions? And what is your best guess in terms of when all of this gets resolved and potential outcomes? Thank you.

Drew Zieglgansberger: Hey Menno, its Drew. Thanks for that question. Yes, it’s an ongoing conversation. I think it’s going to carry through the balance of this year, probably into Q1 from a timing perspective. So, I think it’s going to still takes some time. So, coming back to — I think everybody is kind of pleased to see the asset come available for everyone, that work to ultimately get to the final commercial construct I would expect that to carry out the remainder of this year and potentially drift into the first quarter, even to the first half of next year probably before we finally get to closure on that.

Menno Hulshof: Terrific. Thanks Drew. And then the follow-up is on the — I think I know the answer to this, but — so I’m just looking for confirmation. Just on the comp position of the current asset portfolio, my understanding is that the portfolio is fairly core up. But is there any potential for smaller divestitures over the coming quarters? Or is that still not a priority for the moment?

Jon McKenzie: Yes, I think, Menno, we’ve been really clear that we are really focused on our base business over the next while. You’re quite right. We quite like the asset base that we’ve got. And we are focused on the improvements we’re making in the downstream together with the growth in the upstream with the projects that we laid out at Investor Day. So, we’ve got our plates full over the next few months, and we’re just looking forward to executing on what we think is a pretty robust suite of activities. .

Menno Hulshof: Thanks Jon. I’ll turn it back.

Jon McKenzie: Thanks Menno.

Operator: Thank you. And your next question comes from the line of John Royall from JPMorgan. Please go ahead.

John Royall: Hi, good morning. Thanks for taking my question. So, you gave some color on Superior. But in terms of your other two operated refineries, can you talk about utilization. I think you’re a bit below your target ranges for the year at both Toledo and Lima. And I know there’s a little maintenance in the quarter, but anything to call out there in general, just in terms of getting to those targets near-term?

Keith Chiasson: Hey John, Keith here. It was a really interesting quarter, as Jon talked about in his opening remarks, the low crack spread persisted into January. And so we actually reduced run rates at the start of the quarter. And then obviously, as the market balanced in February 1st, we were really happy with the performance of the refineries as they ramped up to max capacity and capture that crack spread. So, I wouldn’t read too much into it in the first quarter. We do have some maintenance coming in the back end of the year at Lima. But overall, we’re pretty happy with the performance in the assets. And as Jon indicated on a previous question, our sole focus is on continuing the reliability and the margin capture and the profitability of these assets and running them safely and reliably.

And we’re seeing quarter-over-quarter improvement there, manifesting itself in the best throughput the company has had since kind of the merger back in 2021 and Q1 2024. So, pretty happy with the progress, starting to see the progress and we should expect that, that will just continue quarter-over-quarter.

John Royall: Great. Thanks Keith. And then on the base dividend, this is a pretty chunky hike you took today and well ahead of the pace that I think you would need to hit that high 20s per quarter level that you show in your slides by 2028. Was the idea to kind of front-load the bigger increases and slow it to kind of a low double-digit annual rate from here? Just trying to think about how you’re thinking about the base dividend from here?

Kam Sandhar: Hey John, it’s Kam. So, I think the principles around what we discussed at Investor Day haven’t changed. We’ve got, obviously, high confidence in achieving our debt target in the foreseeable future. I think we laid out our five-year business plan. at Investor Day that has a substantial amount of growth starting in 2025 in earnest and moving up towards 2020. But that — the way you should think about the base dividend is, number one, it is absolutely anchored to low commodity prices in that sort of CAD45 WTI range. It’s a level of dividend we view as a commitment and I’d say we’ve left ourselves lots of room to continue to grow that dividend, I’d say, comfortably in double digits going into the future here. So, the increase this year is I think it’s a reflection of the confidence in our plan. It’s a reflection of where the balance sheet is and continue to anchor to bottom of the cycle.

John Royall: Thank you.

Jon McKenzie: Thanks Jon.

Operator: Thank you. And your next question comes from the line of Patrick O’Rourke from ATB Capital Markets. Please go ahead.

Patrick O’Rourke: Hey good morning guys and thanks for taking my question. Just for sort of on the oil sands unit, I think you touched on shifting some of the maintenance into Q2 for Christina Lake there. When I look at the schedule, looks like a little shifted into Q4. Maybe if you could sort of unpack the changes in the maintenance schedule for the oil sands, give us a little bit of color on that here?

Keith Chiasson: Yes, Patrick, it’s Keith here. No real overall change in the annual impact from the Otis, we’re just able to break up the outage into two different chunks. So we’re going to take a little bit of a slowdown here in Q2 at Christina Lake and then finish the turnaround in Q3. And some of that turnaround carries into the first part of Q4. So, all you’re seeing is a little bit different phasing than we originally thought, but overall impacts are the same as we originally put in our guidance. So, — and that’s really it for the oil sands. We have some small outages in Lloyd Thermal, but in general, the rest of the oil sands are running full out for the rest of the year.

Patrick O’Rourke: Okay. Thanks. And I know you sort of had a lot of questions on the return of capital framework thinking on the dividend, et cetera, here. You put sort of the slide in the deck on the change that you’ve made here. In scenario two, where the net debt is below CAD4 billion, you still return the CAD900 million just using the scenario here. Just wondering what would drive this? Because I think working capital build and release kind of equals zero over time, would there be a scenario where you would have to actually return excess free funds, the target return in excess of that to kind of level set to CAD4 billion.

Kam Sandhar: Yes, it’s a good question, Patrick. So, I think number one, I guess, what hasn’t changed is we will do everything we need to do to protect the balance sheet at that CAD4 billion level. And you’re right. The fluctuations you see quarter-by-quarter, around CAD4 billion will largely be influenced by working capital to foreign exchange and other minor things. So, you’re right, the way that we’ve outlined it is above CAD4 billion, we’ll take — we’ll hold back the portion that we’re above and put it back on the balance sheet below CAD4 billion we would pay out 100%. But I think as we move forward, depending on what those fluctuations are in working capital, I would say we do have the discretion to adjust accordingly, and that could mean going slightly above 100%.

It could be meaning being below. But I would say the key for us is — which is different than today is we’ve got a lot of rigidity in our in our structure today around returns. This gives us flexibility to manage both the debt. And if we see opportunity to go slightly above 100%, I wouldn’t rule it out. It’s just I’d say the minimum level would be 100% unless we’re below

Patrick O’Rourke: Okay, great. Thank you very much.

Kam Sandhar: Thanks Patrick.

Operator: Thank you. [Operator Instructions] Your next question comes from the line of Manav Gupta from UBS. Please go ahead.

Manav Gupta: Hi. So, if you look at last year, you were off to a slightly tougher start on their upstream and that resulted in your coming slightly below the midpoint of the guidance in the upstream segment. And knowing you guys, you always try for midpoint or above the midpoint, in fact, towards the top end. So, this year, you are off to a much stronger start. So, should we assume that for 2024, at this point, things are looking where you could actually go and hit the top end of your guidance in upstream?

Jon McKenzie: Yes, I’m not sure we’re going to pinpoint where we are within the range that we’ve already given you for guidance. But we feel very comfortable in the guidance that we’ve given you, Manav. And you’re quite right, the upstream has operated really, really well over the last three or four quarters. The downtick that you saw in Q1 of 2023 was really due to the pacing and staging of our capital program. but we won’t see that kind of gap this year. So, Keith mentioned, we’ve got a turnaround of Christina that we’ve scheduled for the third quarter, and we need to do a good job of that we are very pleased with the production that we’ve seen from the upstream. It’s been very strong. And as everybody knows, that’s really the backbone of this company.

So, having it perform at those levels is something that we’re very pleased with. But I’m not sure we’re ready to tighten that guidance quite yet. I think it’s still pretty early days, but we’re very pleased with where we are.

Manav Gupta: Perfect. My quick follow-up on the downstream is your per unit operating cost in the U.S. is now trending down. It’s like almost CAD12 and I’m trying to wonder, as you start pushing towards 90% plus utilization, right? How much lower can you bring this? Can you push this towards closer to CAD10 or CAD11 on a per unit basis, the operating cost?