Ovintiv: Bad Decisions Put Management In The Penalty Box (NYSE:OVV)

Once we final coated Ovintiv Inc. (NYSE:OVV) (TSX:OVV:CA), we made a transparent bullish name. It was a kind of uncommon shares the place we endorsed the potential of a considerable upside. Particularly we mentioned,

One further issue right here is that 2022 capex budgets will presumably be hit for oil and gasoline firms as they grapple with this new tail threat. Within the shorter time period there could also be extra stress on commodity costs as some firms rush to hedge. This isn’t a nasty thought right here as even promoting calls on some quantity of manufacturing can buffer downswings and presently implied volatility of oil is thru the roof. OVV is properly hedged for 2022, however will presumably additionally add some extra buffers. We reiterate our $50 worth goal for this firm and stay bullish on its prospects.

Supply: 50% Upside Over Subsequent 18 Months

The inventory took an attention-grabbing trajectory and handily exceeded our goal in half the timeframe.

It has pulled again considerably and introduced an enormous deal simply this morning. We look at the basics in mild of those occasions.

The Deal

OVV’s curiosity in shopping for Permian belongings from P-E agency EnCap Investments for about $4 billion in money and inventory, together with debt was reported late Sunday evening. Because it occurs with these offers, the events have a tendency to often finish talks on the leak or extra usually, finalize the small print. The latter occurred on this case and OVV confirmed that that they had signed on the dotted line.

The deal was funded in two methods. 32.6 million shares of OVV shares are to be issued and the remainder of the portion will come from money ($3.125 billion). Whereas the money appears excessively excessive relative to the market capitalization of OVV, will probably be partly funded via the pending sale of the corporate’s Bakken belongings ($825 million). OVV has acquired absolutely dedicated bridge financing from Goldman Sachs (GS) Financial institution USA and Morgan Stanley (MS) for the remainder of the funds.

The acquisition consists of 75,000 barrels of oil equal, or BOE, per day of manufacturing, with about 80% coming from liquids. The undeveloped land portion is fairly massive and makes up about 50,000 acres in Martin and Andrews Counties. At first look the worth paid seems cheap at about $57,000 per BOE/Day. OVV did nonetheless challenge an honest quantity of inventory for this and traders are seemingly sad about that. Why challenge costly inventory for extra belongings? Why challenge inventory that you simply spent cash shopping for again at the next worth?

We agree that half hurts traders, however the various right here goes full debt loaded and we all know how that has labored out for traders within the vitality sector. So whereas we’re not too thrilled with that fairness issuance, it’s nonetheless higher than the choice.

OVV expects this to shut on the finish of Q2-2023, so its up to date steering consists of half yr of manufacturing from these belongings. It additionally assumes closing of the its personal asset sale on the similar timepoint.

The important thing takeaways listed below are that OVV has unloaded some pure gasoline heavy belongings for a extra oil and liquids centered manufacturing.

You’ll be able to see above that pure gasoline manufacturing stays flat whereas whole and oil numbers transfer up. From a pricing level, traders seemingly really feel that this is sensible. In any case, oil is at $80/barrel and pure gasoline is struggling to carry the $2.00/MCF mark. Whereas this seems interesting on paper, OVV has a protracted historical past of chasing the mistaken belongings on the mistaken time.

Its preliminary separation from the corporate now generally known as Cenovus Power (CVE) to concentrate on pure gasoline was a nasty transfer. Its soar into oil once more by shopping for Athlon Power was proper on the peak of oil costs in 2014. It hated pure gasoline once more and hedged its 2022 pure gasoline manufacturing at terrible costs. If that was not unhealthy sufficient, OVV reminded traders that it will not add to its hedges to lock in $7.00/MCF for 2023. They reiterated that hedging was not an excellent thought and gave away tons of money move by stepping into the other way.

If we have been unhedged this yr, our free money move yield would greater than double to nearly 40%. That is an incredible setup for our shareholders going into 2023, and it reinforces our want to repurchase shares with free money move.

Our substantial free money move profile is permitting us to return significant money to our shareholders. Primarily based on our third quarter free money move, we count on to return $250 million to our shareholders within the fourth quarter. This interprets to an annualized money return yield of seven%. If we take away the $821 million influence of our hedges for the calculation, our money return yield would greater than double to about 19%.

Even with out the hedges eliminated, our 7% money return yield is considerably larger than the broader market. When what our money return yield can be on an unhedged foundation, it’s greater than 4x the broader market. The roll-off of our 2022 hedging program is imminent. And once we sit up for 2023, the uplift to our money move technology is substantial and can lead to unbelievable upside for our money return profile.

Supply: OVV Q3-2022 Transcript

What was really imminent was the highest in pure gasoline costs. So right here we’re with yet one more transfer away from pure gasoline after proudly refusing to hedge. This market chasing habits and promoting (hedging) at bottoms and shopping for (letting hedges roll off) at tops is an terrible coverage. Unloading pure gasoline belongings is a continuation of that. Possibly this works out, if the just lately introduced OPEC transfer offers an enormous enhance to the projected money move. However from a technique stand level, you must deduct marks from administration for this.

Valuation and Verdict

OVV continues to be going to get about 35% of its manufacturing from pure gasoline and is totally uncovered on it.

That is as a result of it used three approach collar choices and bought a second put under $2.25-$3.00/mcf.

On the oil facet it has performed the identical factor and total volumes hedged are very small. OVV funding comes down as to whether you are bullish on vitality and may at the least stand some pure gasoline publicity regardless of the very low costs. It additionally comes down as to whether you consider that administration’s unhealthy judgement on hedging will be overcome with a superlative valuation.

We consider that concept nonetheless holds however this isn’t a inventory we wish to chase. That half turns into extra necessary in a recession the place margins can collapse if oil costs comply with pure gasoline down. For our earnings play we selected the $40 strikes on our final commerce.

Regardless of being so deep within the cash, the choices had an incredible return profile. Because it turned out we wanted that margin of security (breakeven at $30.90) as OVV tanked shortly after that. Additionally, because it seems, if OVV ends over $40.00 at expiration, we are going to make greater than initially projected, due to this little nugget.

On April 2, 2023, Ovintiv’s Board of Administrators declared a quarterly dividend of $0.30 per share of widespread inventory payable on June 30, 2023, to shareholders of report as of June 15, 2023. This represents a 20% improve within the Firm’s base dividend fee on an annualized foundation. That is the second improve introduced by Ovintiv within the final 12 months.

Supply: Ovintiv

We nonetheless price the shares as a “purchase” and suppose $50 will be reached once more over time. We might put administration within the penalty field right here although and see if they’ll ship the manufacturing numbers whereas holding the road on capex. Their debt to EBITDA targets should even be watched. There is a motive that OVV has underperformed Power Choose Sector SPDR (XLE) by 182.6% since 2010.

Please word that this isn’t monetary recommendation. It could appear to be it, sound prefer it, however surprisingly, it isn’t. Traders are anticipated to do their very own due diligence and seek the advice of with an expert who is aware of their targets and constraints.