Ovintiv: Will they *Burry* Shorts?
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Summary
Ovintiv Inc. has been enjoying higher oil prices and the consequent higher free cash flow.
Can the company move past its checkered past?
A famous investor certainly thinks so.
Ovintiv Inc. (OVV) has a far longer history than its recently acquired name. It was originally known as Encana. It was founded and headquartered in Calgary, Alberta and at one point was the largest energy company and largest natural gas producer in Canada. Through a series of bad decisions the company continued to lose its leadership and market capitalization.
Between 2006 and 2008, the company got rid of many of its oil assets and then its oil sands division in form of spinning out Cenovus (CVE) to shareholders. The company doubled down on natural gas at what was the worst possible time. The natural gas focus hurt the company extra hard during the next downturn. Investors might remember that oil prices held rather firm between 2009 and 2014 while natural gas prices scrapped the bottom. One of the things that made this worse was a complete disdain for rational capital allocation by the company. OVV alongside the pioneers of capital destruction, Chesapeake Energy Corporation (CHK) just seemed to have no ability to see the glaring signs of oversupply forming in the natural gas markets. Below we show CHK's natural gas production binge (shown in oil equivalent barrels).
In 2014 after years of poor natural gas prices, OVV decided a change was required and decided to pursue a liquids focus. It bought Athlon Energy for $7.1 billion. Considering the normal lag between deal negotiation and announcement (red circle below), OVV top ticked that oil move in a sweet manner.
Late in 2019, the company was rebranded as Ovintiv as nothing says "we have changed" like garbled bunch of letters. The total return of OVV benchmarked against some of its Canadian and US peers shows the frustration shareholders might be feeling today.
Where Things Stand
While OVV has likely made more errors than most of the surviving E&P plays, there have been things outside its control that have made the challenges worse. One big problem has been the massive valuation compression in the space. That valuation compression has made issuing equity impossible at almost any recent timepoint. OVV has thus rightly focused on debt reduction and it is getting the story correct.
Debt has now fallen below the equity market value and further reductions are planned as well. With $1.7 billion of free cash flow at a weighted strip price of $65/barrel oil, the company is now trading at a greater than 25% free cash flow yield.
OVV is also being helped by an oil services industry that currently has zero pricing power. OVV has thus delivered costs that continue to come in below original guidance.
The falling costs have allowed OVV to boost guidance while keeping capex the same.
A few select quotes from their CEO:
“With our reaffirmed capital budget and over $3.2 billion of estimated 2021 cash flow at strip prices, we are achieving a reinvestment ratio of less than 50%, substantially below our 75% investment framework. These outstanding results allow us to reinforce our commitment to shareholder returns as we return our efficiency gains to our investors.”
“Yesterday, we announced a number of new actions that reflect the sustainability of our business model and the tremendous performance of our organization.”
“First, we are increasing our base dividend by nearly 50%. This substantial increase reflects the confidence we have in the growing cash flow capacity of our business. As a reminder, not only did we leave our dividend untouched during the recent downturn, but this raise marks the second increase since 2019. We are delivering in our commitment to return cash to our shareholders. And we see a growing base dividend as an important part of the value proposition for our owners. Second, we have set a new debt target of $3 billion to be achieved by year-end 2023.”
Source: OVV Q2-2021 Transcript
We can see this also in the way the orange line below has stayed consistently above the blue one since 2019.
The Big Long
Michael Burry has made some incredibly bold and accurate calls over the years. In the most recent quarter, he added 600,000 shares of OVV alongside doubling down on the idea that private prisons were not going to be added to the endangered species list.
Source: Data Roma
While OVV stock has risen from the ashes and short interest has been falling, there is certainly room for improvement on both fronts. Short interest is still higher than peers and OVV also trades at a large valuation discount to its peers.
Let's also keep in mind also that the whole space is priced as if Elon Musk is about to unveil a solar powered car next week.
Despite the most ambitious of targets, the world will continue to need large amounts of oil and gas. So a move to 7x EV to EBITDA multiples over the long run seems rather reasonable. If this is coupled with buybacks and debt reduction, it is easy to see why OVV can double from here even with $55/barrel oil price. OVV has also moved its hedges higher over time as prices moved up. This means that OVV has a lot more buffer on the downside. In both Q1-2021 and Q2-2021, hedges detracted from performance. But the forward hedges are at much higher strikes and they will substantially backstop cash flow if oil moves lower.
Source: OVV Q2-2021 Presentation
Michael Burry has the right idea here and OVV is "hard to lose" case as long as management sticks to the script. There was change at the top recently, with CEO Douglas Suttles paving the way for Brendan McCracken. Brendan has been with the company for a long time and we don't believe he will try anything different. OVV remains an interesting alternative to the overvalued equity markets and it does not hurt to have one of the smartest investors thinking the same.