Cenovus Vitality: Most well-liked Shares Might Yield 8-12% Upon Reset (OTCMKTS:CNVEF)

Introduction

Cenovus Vitality (NYSE:CVE) (TSX:CVE:CA) is a big built-in oil and gasoline producer in Canada. The corporate produced in extra of 700,000 barrels of oil-equivalent per day whereas its downstream throughput averaged in extra of half one million barrels per day. The entire capability is kind of a bit increased however a few of the amenities had been down for upkeep.

On this article, I’ll clarify why I believe a few of the most well-liked shares issued by Cenovus may very well be fascinating to personal. In Canada, most fix-to-float most well-liked shares lock in a most well-liked dividend for a interval of 5 years and that makes a few of the most well-liked share points fairly interesting.

The corporate is buzzing alongside properly

I will not go into an excessive amount of element on the monetary outcomes as the popular fairness is the primary focus of this text and the 2 necessary parts are the popular dividend protection ratio and the asset protection ratio. There are loads of authors right here on Looking for Alpha with good articles on Cenovus Vitality and I would encourage you to learn a few of their articles to get a greater understanding of the corporate.

The corporate reported a complete income of C$12.2B within the second quarter of the 12 months – I’ll use the corporate’s Q2 outcomes as these are based mostly on a US$75 Brent and a C$74 WCS oil worth. The oil and bitumen costs are considerably increased and had been increased all through the third quarter so whereas I am anticipating a robust end result within the third quarter, I am utilizing the Q2 outcomes for a extra conservative method.

As you may see above, the corporate reported a web revenue of C$866M which represented an EPS of C$0.45. Curiously, Cenovus didn’t report any most well-liked share dividends from the reported web earnings, and after deducting the C$9M in most well-liked dividend funds, the online earnings attributable to the shareholders of Cenovus was C$857M, as you may see under.

That is necessary: It implies that, at US$75 WTI and C$75 WCS and the refineries not working at full capability, the corporate wanted simply 1% of its web earnings to cowl the popular dividend funds. Expressed in a proportion, the popular dividend protection ratio was 9,600%.

A second component I wish to verify is the asset protection ratio. As of the tip of June, Cenovus had nearly C$54B in belongings and the fairness element of the steadiness sheet was C$27.3B. The corporate additionally had C$2.2B in money whereas its long-term debt totalled C$8.5B for a web debt place of C$6.4B (rounded).

As of the tip of June, the corporate additionally had 36 million most well-liked shares excellent. All most well-liked shares have a principal worth of C$25 per share, which implies Cenovus had about C$900M in most well-liked fairness on the steadiness sheet. Which means there’s about C$26.3B in fairness ranked junior to the popular shares and even if you happen to would exclude the C$2.9B in goodwill on the steadiness sheet, there’s in extra of C$23B in tangible fairness on the steadiness sheet that ranks junior to the popular shares.

Lengthy story brief, I am very proud of the popular dividend protection ratio and the asset protection ratio.

A better have a look at the popular shares

I used to maintain observe of the popular shares of Husky Vitality, however these shares had fairly low yields when the rates of interest on the monetary markets had been low. This has clearly modified and though the underlying firm is now a lot bigger (when Cenovus acquired Husky Vitality, the popular shares merely remained excellent) and the upper rates of interest on the monetary markets create alternatives.

I am preserving a detailed tab on the Collection 1 (OTC:CNVEF) (TSX:CVE.PR.A:CA) and Collection 3 most well-liked shares (TSX:CVE.PR.C:CA) issued by Cenovus. Each points at present have comparatively low most well-liked dividends however the subsequent reset dates are coming shut. Because the picture under reveals, the Collection 3 will reset first, on the finish of subsequent 12 months, whereas the Collection 1 will reset in Q1 2026.

Wanting on the Collection 3, these most well-liked shares are buying and selling at C$19.25 (the principal worth is C$25 per most well-liked share) and that sequence at present yields 4.69% or C$1.1725 per share per 12 months. And based mostly on the present share worth, the present yield is roughly 6.1%. Not dangerous, but in addition not nice.

Nevertheless, on the finish of 2024, the popular dividend price of these most well-liked shares will reset to the five-year Canada authorities bond yield plus a mark-up of 313 foundation factors. The five-year Canada authorities bond yield is at present buying and selling at 4.15% which implies that within the present scenario, the popular dividend on the Collection 3 would reset to 4.15% + 3.13% = 7.28%. This represents C$1.82 per 12 months and would lead to a yield of 9.5% based mostly on the present most well-liked share worth.

We can also run the numbers from a unique angle. The query may very well be “how excessive ought to the five-year Canada bond yield be to generate 7% on my funding after the reset date?.” That is a straightforward one. The required most well-liked dividend is C$1.3475 per share per 12 months (7% of C$19.25). That represents 5.39% of the C$25 principal worth and contemplating we all know the mark-up is 313 bp, so long as the five-year Canada authorities bond yield exceeds 2.26%, you’ll earn at the very least 7% in your funding within the 2025-2030 interval. And that is a wager I am keen to take. Even when the 5Y bond yield drops to three%, you’d obtain an 8% most well-liked dividend yield based mostly on a price foundation of C$19.25.

We see the same consequence for the Collection 1 most well-liked shares though that one may very well be trickier due to the decrease mark-up. Whereas the mark-up is 313 bp for the Collection 3, the Collection 1 has a mark-up of solely 173 bp. These most well-liked shares are at present buying and selling at C$11.78 for a yield of 5.5%.

We will now run the numbers based mostly on comparable assumptions. The present five-year authorities bond yield is 4.15%. However let’s assume a long-term yield of three%. Which means in Q1 2026, the popular dividend yield would reset to three% + 1.73% = 4.73% or C$1.18/share. Which might imply that based mostly on the present share worth, you possibly can really lock in a yield of 10% for the five-year interval beginning in 2026. Making use of the present five-year bond yield would lead to a yield of near 12.5%.

And because of the low mark-up, the percentages of Cenovus calling this particular sequence are fairly low. As all different sequence of most well-liked shares have increased mark-ups, it might make extra sense for Cenovus to name the dearer most well-liked shares first.

Funding thesis

And that is why income-focused traders ought to most undoubtedly have a more in-depth have a look at the popular shares issued by Cenovus. I do just like the Collection 1 as a result of I am locking in a 5.5% yield till Q1 2026 and the rates of interest must collapse fully earlier than I might not see a considerable yield improve. If I am aiming for a 7% yield from Q1 2026 on, all I want is a 5 12 months authorities bond yield of 1.57%. And I like these odds.

Moreover, even when the corporate would see its most well-liked dividend funds improve by 50%, it might nonetheless be paying lower than C$15M per quarter and fewer than C$60M per 12 months on most well-liked dividends. On the similar time, the overall face worth of the popular shares is C$900M whereas the present market worth is lower than C$650M. And maybe Cenovus Vitality ought to attempt to purchase again a few of its most well-liked shares earlier than their respective reset dates.

I at present don’t have any place in Cenovus Vitality nor in its most well-liked shares however I’ll provoke a protracted place within the Collection 1 most well-liked shares in anticipation of a most well-liked dividend reset in 2026.

Editor’s Word: This text discusses a number of securities that don’t commerce on a serious U.S. alternate. Please pay attention to the dangers related to these shares.