Star-Studded Canadian Stocks Tour: CNQ, North American energy giant that has raised its dividend for two decades in a row

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Canadian Natural Resources Limited is an independent crude oil and natural gas exploration, development and production company. The company's exploration and production operations are concentrated in North America (primarily in Western Canada), the United Kingdom in the North Sea, and Cote d 'Ivoire and South Africa off the coast of Africa. CNQ currently holds the largest crude oil reserves and the largest natural gas reserves among Canadian producers and is one of the largest oil and gas producers in Western Canada.

CNQ's main business includes the following aspects:

Exploration & Production: CNQ's exploration and production operations are domestically concentrated in the western Canadian basin, located in the Montney Basin and Deep Basin along the Rocky Mountain slopes. Foreign sources include the British part of the North Sea, as well as Ivory Coast and South Africa off the coast of Africa. This business accounted for 51.03% of CNQ's total revenue in 2023

Oil Sands Mining: The Oil Sands Mining and Upgrading segment produces synthetic crude Oil directly or indirectly through its bitumen mining and upgrading operations in the Horizon Oil Sands in northeastern Alberta, Canada, and the Athabasca Oil Sands project in the same region. The oil sands business accounted for 45.71% of total revenue in 2023

Midstream and oil refining: CNQ's Midstream and Refining segment is located primarily in Western Canada and serves its upstream mining and production operations, including pipeline operations, electric combined heat and power systems, and its investment in Northwest Redwater Partnership, a general partnership formed to upgrade and refine bitumen in Alberta. This segment accounts for 2.45% of the company's total revenue in 2023

In terms of products sold, oil and LNG accounted for 93.5% of total revenue in 2023, while natural gas accounted for 6.5%

The exploration and production of crude oil and natural gas, as well as the exploitation and upgrading of oil sands are CNQ's two major businesses, and the investment in pipeline and power in the middle stream serves the core mining and production business in the upstream. It can be seen that the market demand and price of crude oil and natural gas will greatly affect CNQ's revenue. At the same time, the supply changes of its large international competitors, including OPEC, the United States and other producers, will also affect CNQ's market share and revenue.

CNQ has the largest crude oil reserves and the largest natural gas reserves among its Canadian peers, and it is also the only Canadian producer with more than 5 billion barrels of proven reserves, plus developed reserves, totaling more than 10 billion barrels of oil equivalent, which corresponds to CNQ's reserve life index of more than 30 years, according to company statistics. Its total production for the first quarter of 2024 averaged about 1.33 million barrels of oil equivalent per day. BOE, which stands for "barrels of oil equivalent," was up 0.8% from last year's production of 1.32 million barrels of oil equivalent.

Compared to its competitors, CNQ has a low corporate decline rate (the rate at which oil production from a field declines over time). Unlike shale mining, which is popular in the US market, CNQ uses oil sands mining to obtain oil. This kind of project requires a lot of upfront investment, but because of geological reasons, once operational, production decline rate is close to zero. In shale production, new Wells need to be continuously added to maintain production due to field pressure. At the same time, 56% of CNQ's strong reserves are high-value SCO, light crude oil and liquefied natural gas, and most of these assets also have low decline rates. Therefore, for CNQ, which already has mature mining equipment and capital, the required capital expenditure is relatively low. A comparison of CNQ's cash flow metrics with its U.S. E&P lenders shows that over the past 10 years, CNQ's average capex has been 7% of its total assets, lower than most of its peers.

At the same time, according to the company's report published in June, CNQ's breakeven price is around $40, well below the current level of crude oil prices. And its oil sands business has a break-even point of between $20 and $30 WTI, well below the average of its peers, putting it in a good position at current oil prices. CNQ's advantage of capital expenditure and break-even point is conducive to the upward conversion of its operating cash into a large amount of free cash flow. CNQ's average annual return on cash on assets was 6.4%. According to the company's report released in June, its net debt was about $9.9 billion at the end of 2023, while its free cash flow reached $6.9 billion after deducting dividends.

CNQ has not only stable cash flow, but also above-average shareholder returns. The 2023 shareholder return is approximately $3.30 per share, while the three-year total return reaches $1.7 billion, including approximately $600 million reduced through buybacks and approximately $1.1 billion in dividend distributions. The company has also raised its dividend for 24 consecutive years, with a compound annual growth rate of 21%, and its dividend yield is close to 4%. In contrast, Sinovos Energy and Imperial Oil, which are more profitable than CNQ in the industry, have dividend yields of only about 2%. In contrast to other producers' strategies of cutting dividends when commodity prices fall, CNQ's dividend has remained and increased. Its 2022 dividend is subject to an additional special dividend of $0.75 per share on top of the base dividend of $1.42 per share; Its 2024 annualized dividend will increase to $2.10 per share from $1.78 in the prior year.

In 2023, CNQ repurchased a total of approximately 40 million common shares at a weighted average price of $82.86 per share, representing approximately 3.75% of the total share capital. On February 28, 2024, the Board of Directors approved the decision that the Company may repurchase up to 10% of the public shareholding during the 12-month period from March 13, 2024 to March 12, 2025. However, it should be noted that according to its buyback plan and actual buyback last year, it may buy back about 4% in 2024.

It is worth noting that CNQ has proposed a plan to distribute 100% of free cash flow to shareholders when the company's net debt falls below $10 billion. At the end of 2023, its net debt has reached $9.9 billion, suggesting that its shareholder returns will continue to rise in 2024.

While total U.S. oil production is slightly above pre-pandemic levels, its recovery has been driven by the completion of previous drilling (developed but not completed), not by the number of newly developed Wells. According to YCharts statistics, the number of RIGS drilling in the United States is well below pre-2020 levels, and crude oil storage is at a historic position. As a result, U.S. oil production should decline unless U.S. oil development companies reinvest capital in drilling numbers. Most producers are pessimistic about long-term oil demand, so U.S. crude production is likely to decline in the short term.

At the same time, the current international situation is volatile, oil production and transportation in the Middle East and Central Asia are unstable, and ongoing geopolitical issues will lead to global crude oil shortages, especially in Europe. Coupled with the continuation of the OPEC production cut agreement, according to OPEC data, Saudi Arabia and other producers have recently significantly reduced oil production, making OPEC+ market share fell to less than 34%.

Instability in the two major oil exporting regions will prompt oil importers and companies to seek to diversify their supply sources and reduce their dependence on specific regions, which will create market opportunities and potential market share for Canadian oil producers such as CNQ.

Although the current Biden administration hopes to stabilize and lower oil prices by releasing strategic petroleum reserves and encouraging domestic oil production, OPEC has maintained its production reduction strategy and hopes to stabilize the price floor at $80, and OPEC has stressed that if the price falls below this level, it will further reduce production. A counterbalance of objectives would reduce the risk of a sharp fall in oil prices. At the same time, the expectation of lower interest rates in North America is conducive to the improvement of oil prices.

Even if demand for oil falls as a result of an unexpected recession, unlike in 2020, global oil reserves are low, so there is still a lot of buying potential in the global market even if prices fall accordingly.

In the short term, CNQ expects its production to increase in the second half of the year. In April this year, CNQ successfully completed the renovation plan of the Jackfish oilfield ahead of schedule. As a result of the early completion, according to UBS forecasts, it will increase the impact of 2Q24 production to 1.8 million barrels per day. Meanwhile, in Jackfish, CNQ drilled two SAGD blocks in 2023, the first of which reached full production capacity in April 2024 and the second block is targeted to reach full production capacity in the fourth quarter of 2024. At AOSP, the Scotford Upgrader debottlenecking project (approximately 6kbd) is targeted for completion within Scotford's fourth-quarter turnaround period of 24 years. In the medium term, the Company expects the naphtha Recovery Unit Tailings Treatment (NRUTT) project to add approximately 6,000 barrels per day of capacity at Horizon by 3Q27, while the IPEP and PFT projects could add approximately 195 thousand barrels per day of production in the longer term, up from approximately 750,000 barrels per day in the previous project scale.

At the same time as increasing production, Canada and CNQ are also actively improving the transportation of Canadian oil output. One of the main reasons for the price gap between Canadian crude oil prices WCS and U.S. crude oil prices WTI is that Canada's crude oil delivery capacity is lagging behind, and the country has not yet built enough pipeline traffic to support crude oil to industrial areas such as the Gulf of Mexico. According to Bloomberg News, Canada is building the Trans Mountain pipeline, which is expected to triple the amount of oil transported from the coast.

Meanwhile, CNQ itself increased its pipeline capacity at Flanagan South by 55 thousand barrels per day to 77.5 thousand barrels per day through the open season process, which is used to determine and allocate available capacity for oil and gas pipelines, providing the company with greater transportation access. CNQ also holds TMX commitments of approximately 94 thousand barrels per day. TMX will be sold both onshore and offshore, providing CNQ with further diversification opportunities on the West Coast.

In general, CNQ, as Canada's oil and gas mining giant, has the largest crude oil reserves and the largest natural gas reserves in the domestic industry. Its large and stable reserve resources, low decline rate and break-even point below market price drive its free cash flow flow. At the same time, its shareholder return has also increased steadily for two decades, creating a good valuation and market expectations. According to market expectations, geopolitical factors and the possible reduction of oil production in the United States will also create potential market space for CNQ in the future. From the company's point of view, its continued development of new projects and increased transportation capacity will also benefit its second half and long-term production growth. In terms of shareholder return, the company plans to distribute 100% of free cash flow to shareholders once it reaches less than $10 billion. At the end of 2023, its net debt has reached $9.9 billion, meaning that its shareholder return in 2024 will continue to rise, while it is already leading the industry. These benefits are also reflected in the high valuation given to CNQ by the market. According to Bloomberg forecasts, the decline in earnings per share in 2024 will slow significantly, narrowing from -33.23% in 2023 to -6.19%, and it is expected that earnings per share will recover in 2025, with a growth rate of 21.36%. Revenue declines are also forecast to narrow in 2024 and recover with a 5.4% increase in 2025. Although in the short term its production was adversely affected by the volatility of oil prices and the wildfires in Canada and subsequent maintenance, the company will continue to maintain its good revenue and financial performance in the long term.

However, as the industry is extremely dependent on market prices and supply changes from large-scale competitors, any change in strategy by the United States, OPEC, etc., could cause oil or gas prices to weaken, adversely affecting CNQ's product exports. At the same time, investors should also reasonably judge whether the valuation still has upside or overvaluation in the case of declining earnings per share, and can wait for the right time to buy.