Cenovus Energy (CVE) Tops Q2 EPS by 5c; Cuts Dividend

Cenovus Energy (NYSE: CVE) reported Q2 EPS of $0.15, $0.05 better than the analyst estimate of $0.10.

Dividend updateWith the expectation of a prolonged period of low oil prices and the cash flow impact from the sale of its royalty and fee land business, Cenovus is reducing its dividend by 40%. The Board of Directors has declared a third quarter dividend of $0.16 per share, payable on September 30, 2015 to common shareholders of record as of September 15, 2015. Based on the July 29, 2015 closing share price on the Toronto Stock Exchange of $18.61, this represents an annualized yield of about 3.4%. Declaration of dividends is at the sole discretion of the Board and will continue to be evaluated on a quarterly basis. Over the long term, Cenovus intends to target a dividend payout ratio of 20% to 25% of after-tax cash flows. With this dividend reduction, the company is on track to be within its target range for 2015.

Cenovus has discontinued the temporary discount on its Dividend Reinvestment Plan (DRIP). The discount, which allowed shareholders to reinvest their dividends in Cenovus common shares at 3% below current market prices, was designed to conserve cash. Cenovus now believes it has adequate liquidity to manage through the low oil price environment, and the discount on the DRIP is no longer required. While the DRIP will remain in place, in future, common shares acquired under the DRIP will be purchased in the open market, eliminating the dilution caused by the issuance of shares from Treasury.

Cost reductionsCenovus continues to make solid progress attacking cost structures across the entire company to reduce its spend and create sustainable cost improvements. The company previously announced a target of $200 million in upstream operating, capital and G&A cost savings for 2015, which were largely achieved within the first six months of the year. As a result, the company is increasing its cost-cutting expectation for 2015 to approximately $280 million, 40% higher than its initial target.

Part of the company's cost-cutting efforts has focused on workforce. In February, Cenovus announced initial plans to reduce its workforce by approximately 800 positions to align with capital budget reductions for the year. The company has since identified 300 to 400 positions at its Calgary offices that are expected to be eliminated before the end of 2015. These positions are no longer required because of a decrease in work due to the continued low oil price environment. Cenovus also intends to review the company's compensation, benefits and time-off practices to ensure they align with current and anticipated market conditions. The cost savings associated with these additional workforce efficiencies are expected to be at least $100 million annually. Because the full impact of these workforce savings is still being finalized and will likely be more evident in 2016, they have not been included in the company's $280 million overall cost-reduction target for this year.

Cenovus is also planning for additional staff reductions at its field operations in early 2016, as the company continues to identify even greater workforce efficiencies. Details of these additional reductions will be provided at a later date.

"Reducing the size of our talented workforce was not an easy decision, but it's the right one," said Ferguson. "The new economic reality for our industry includes low oil prices and competition from light tight oil in the U.S. To help ensure our continued success, we must adapt by reducing all of our costs and becoming as efficient as possible."

Specific examples of cost savings already achieved or underway this year include:

• The centralization of Cenovus's supply chain management team to allow for greater standardization of supplies and services, a reduction in the overall number of suppliers and more effective management of the company's spend
• An innovation in the design of well pads at oil sands sites to reduce the amount of area and infrastructure needed, which is anticipated to result in significant sustained capital and operating cost savings
• Improved drilling and completion processes
• Greater standardization of facility and infrastructure design
• Reduced supplier costs for on-site pipeline installation
• Improvements to oil sands waste disposal and handling processes

Of the company's targeted 2015 savings, about two-thirds are expected to come from operating cost improvements with the remainder related to reduced capital spending as well as lower G&A expenses. Cenovus anticipates about half of these savings will be sustainable over the long term.

More efficient organizational modelCenovus also continues to make substantive progress with its transition to a new organizational model, which will help the company optimize its workflows, better utilize its people and expertise and achieve efficiencies that will lead to sustainable reductions in its overall cost structures. Under the new model, teams are being organized by function and aligned with the company's value chain as opposed to specific assets. Cenovus plans to have its functional model structure in place by the end of the year. The move is expected to result in additional workforce efficiencies.

Cenovus is also realigning the structure of its Leadership Team to better fit with the functional model. The planned retirements of four Executive Vice-Presidents announced this May are proceeding as expected. To minimize disruption to Cenovus's business and ensure the transitions are orderly and managed, the retiring executives will continue in varying capacities until the end of the first quarter of 2016. As a result of Cenovus's strong focus on internal succession planning, three of the vacancies on the Leadership Team are being filled by internal candidates who are being promoted to newly-restructured portfolios. In addition, an external search is well underway for a President, Upstream Oil & Gas, who will be responsible for the company's oil sands and conventional operations. Cenovus expects to have that candidate identified by September.

Disciplined capital allocationCenovus continues to focus on capital discipline, with its oil sands assets remaining its top priority for capital allocation. The company anticipates that 2015 capital spending will remain within its previously announced guidance of $1.8 billion to $2.0 billion.

In its first five years of operations, the company generated a compound annual production growth rate of 24% from its jointly owned Foster Creek and Christina Lake oil sands projects. In response to the company's expectations for a continued low oil-price environment, Cenovus is taking a more moderate and staged approach to expanding these assets. Rather than pursuing multiple major construction projects at the same time, the company will consider expanding existing projects and developing emerging opportunities only when it believes it can do so with the greatest efficiency and cost savings, while generating the greatest potential return for shareholders. The company is no longer targeting to achieve 500,000 barrels per day (bbls/d) of net oil production by 2021.

For the remainder of 2015, Cenovus's capital investment priorities are:

• Sustaining existing oil sands production
• Completing the ongoing Foster Creek phase G expansion
• Completing the ongoing Christina Lake optimization and phase F expansion

These projects remain on schedule and are expected to add approximately 100,000 bbls/d of incremental gross production capacity (50,000 bbls/d net) by the end of 2016, an increase of about 25% to the company's current total crude oil production volumes once the phases are at full operational capacity.

For 2016, Cenovus is considering investing capital in additional expansion projects that were deferred earlier this year. With considerable strength on its balance sheet and the sustained reductions already achieved, the company has the financial capability to resume those projects when it feels the timing is right. Those investment decisions would be based on oil price stability, continued balance sheet strength, the company's ongoing cost-cutting success as well as fiscal and regulatory certainty. Cenovus is allocating between $25 million and $30 million for the remainder of 2015 to prepare for the possibility of construction resuming on some of these projects next year.

Once a decision is made to proceed, Cenovus's priority would be to allocate capital to re-start construction at its deferred Christina Lake phase G and Foster Creek phase H expansions. The next priority would be to resume work at the Narrows Lake oil sands project. These projects have the ability to provide top-tier returns.

As with its oil sands operations, Cenovus is also taking a more moderate approach to investing in its conventional oil opportunities, with a focus on drilling projects that are considered to be relatively low risk, with short production cycle times and expected returns well in excess of the company's internal hurdle rate of 15%. As part of this strategy, Cenovus is currently directing capital to resume drilling at the company's tight oil projects in southeast Alberta, where it has experienced success in recent years, and at its Weyburn enhanced oil recovery project in Saskatchewan, which benefits from strong netbacks and returns at current prices. Cenovus has allocated $70 million, activating three rigs, to resume its conventional drilling program in the third quarter. The company has no plans to allocate additional capital to its Pelican Lake or other conventional projects this year.

Cenovus continues to believe in the long-term potential of its emerging projects, including Telephone Lake and Grand Rapids. At this time though, plans for development of these projects have been deferred, as the company continues to work on new technology and process improvements that are expected to further reduce capital and operating costs for those assets.

The company expects to provide further clarity around its capital investment plans when it releases its 2016 budget in December.

Value creation & portfolio managementDuring the quarter, Cenovus announced an agreement to sell Heritage Royalty Limited Partnership (HRP), a wholly owned subsidiary holding the company's royalty and fee land business. Included in the agreement were associated royalties on third-party interest volumes and on Cenovus's working interest production as well as a Gross Overriding Royalty (GORR) on the company's Pelican Lake and Weyburn production. The sale, which closed on July 29, 2015, generated gross cash proceeds of $3.3 billion, with an expected after-tax gain of approximately $1.9 billion, to be recorded in the third quarter. The proceeds further supplement Cenovus's strong balance sheet and ongoing prudent management of its finances. On a pro forma basis, including the proceeds from the sale of its royalty and fee land business, Cenovus would have had a second quarter net debt to capitalization ratio of 7%, with net debt to adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) of 0.3 times. The transaction provides the company with the flexibility to invest in projects that offer the greatest returns for shareholders over the near- and medium-term, when oil prices are expected to remain low. At current oil and gas prices, the transaction is expected to reduce Cenovus's future cash flow by approximately $120 million annually.

On June 4, 2015, Cenovus announced an agreement to purchase a crude-by-rail trans-loading facility located in Bruderheim, Alberta for approximately $75 million. The purchase supports the company's strategy of increasing transportation options to maximize access to global markets where it expects to capture higher prices for its oil. The transaction is expected to close August 31, 2015, subject to certain conditions.

Cenovus maintains an active portfolio management program, continuously assessing both acquisition and divestiture opportunities. As part of its strategy to add shareholder value, the company continues to look for opportunities to crystallize additional value from its conventional portfolio, as it did with the HRP sale. Cenovus's conventional oil and natural gas assets have historically provided reliable cash flow, well in excess of their capital investment requirements, to fund the company's oil sands expansions. As production from the oil sands assets grows and they contribute increasing free cash flow, the strategic value of some of its conventional assets has become less important than in previous years.

While Cenovus continues to believe in the value of its integrated strategy, which includes its refineries, the company has no pending plans to invest in additional downstream assets. It would consider a downstream acquisition only if it offers compelling value and strategic fit, as was identified with the recent Bruderheim rail facility transaction.

For earnings history and earnings-related data on Cenovus Energy (CVE) click here.

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