Despite a massive push toward renewables, the oil and gas industry remains the most vital component to the global energy mix. This puts Ovintiv Inc. (OVV, Financial) in a good position.
Originally known as Encana, the company was the largest energy company and the largest natural gas producer in Canada before relocating to the U.S. in 2020 and rebranding as Ovintiv.
America and the world still need more energy. First, the high-energy density of oil and gas provides substantial energy relative to their volume, making them ideal for applications like transportation. Second, the existing infrastructure for oil and gas extraction, refining and distribution is extensive and represents a significant investment. Third, oil and gas are economically important, contributing to job creation, tax revenues and economic stability in many regions. These traits alone will keep the industry viable for at least another generation. Global energy demand is rising, especially in developing economies, and oil and gas will continue to play a crucial role alongside renewable energy sources. I think that will be the case even in the U.S., where regulations seem to be tightening.
Ovintiv’s production
At the end of 2022, Ovintiv had proven reserves north of 2.3 billion barrels of oil equivalent. Further, the company is expected to produce in the range of 520,000 to 546,000 BOE per day for 2023. Of that, approximately 26% is petroleum, 25% is natural gas liquids and 49% is natural gas.
That means 598 million barrels of oil, at $74 for Brent, which equates to nearly $50 billion. That alone is 5 times Ovintiv’s market capitalization. Then add the value of natural gas and liquid natural gas to tack on another $17 billion and $27 billion respectively. Collectively, this comes out to a stockpile worth nearly $100 billion. The current market capitalization is around $10 billion.
Competitive advantage
Based on the company's current position and the broader trends in the energy industry, there are several reasons why Ovintiv should be around in 20 years. The demand for petroleum and natural gas is expected to remain significant in the coming decades, particularly in emerging markets. The U.S. is a massive energy producer and consumer. This ongoing demand will surely support Ovintiv’s continued growth.
The company has a long history in the energy industry, dating back to its origins as Encana. This history provides the company with extensive industry knowledge and experience. It also has a diversified portfolio of assets across the U.S. and Canada, helping to mitigate risks associated with production or regulation from any one region. Ovintiv’s decision to rebrand and relocate shows a willingness to adapt to changing market conditions and strategic priorities. That said, the strongest advantage the company has is its massive acreage of natural gas and oil assets.
Latest report
Ovintiv issued strong first-quarter earnings last month. The company generated $241 million in non-GAAP free cash flow and returned approximately $300 million to shareholders through dividends and buybacks. The company also announced a 20% increase in its base dividend to $1.20 per share, bringing the annual yield up to 3.4%.
During the quarter, Ovintiv exceeded its production guidance, with strong well results across the portfolio, particularly in the Permian Basin region with a record of over 180,000 of barrels of oil per day, a 35% increase compared to the three-year average.
In April, the company also announced the acquisition of assets in the Midland Basin for $4.27 billion and the divestiture of its Bakken assets for $825 million. The transaction is expected to be immediately accretive, with next 12 months accretion per share of 14% for cash flow, over 30% for free cash flow and over 25% for shareholder returns. The acquisition included roughly 65,000 acres that are expected to contribute 75,000 BOE per day with 80% being oil and condensate.
Ovintiv continues to be successful in the quest for more efficiency and expects to further reduce lease operating expenses, transportation and processing costs, with a 15% improvement across the board in capital efficiency.
Thoughts on valuation
Maybe the price of oil will come down as demand is regulated away with electric vehicles and clean energy to power homes and buildings. I am skeptical that cutting out on fossil fuels is approaching reality anytime soon. Even Elon Musk understands the need for fossil fuels for the next decade or more, which brings me back to how ridiculously cheap Ovintiv looks.
First off, the company’s 50% gross profit margin goes a long way toward net profit. It does not really spend that much on selling, general and administration costs. However, with a proven reserve index of just over 12 years, it may need to keep spending money on new land, but only time will tell. With a long-term debt load of $3.1 billion and operating cash flow exceeding $4.2 billion, it should not have any issues financing future investments.
More importantly is the question of how long the current oil and natural gas industries will be viable to the first world we know today. And, if there is a shift, will companies in America be able to continue production under any new regulatory changes? Somewhere in the world, people will want our oil and natural gas even if we are not able to use it.
If this was just a math problem and we assume the company will run out of reserves in 12 years at its current production rate, then even if it became even more efficient, there is a cap on how much capital can be extracted. Last year, capital expenditures were approximately 46% of net income. A simple calculation would then leave around $28 billion total over the next 12 years, without adding or subtracting any asset or liability movements. Even if long-term debt is taken out entirely, the number would still be close to $25 billion, nearly 150% higher than the current market value.
That said, it is very likely Ovintiv will be around in 12 years. It is also just as likely it will have paid out at least $1.20 per share over that time and be producing a similar or greater amount of BOE per year.
