Shares of the Canadian oil producer Crescent Point Energy (CPG 2.60%) have gained 27.9% in September while the S&P 500 is up just 1.5%. Yet, over the last 12 months, the stock price is down 28.0% while the S&P 500 is up 3.55%.
The recent strong performance is related to the price increase of the WTI -- the U.S. oil benchmark -- but the market still undervalues the company despite its improving situation.
Over the last several years, the company has increased its debt and diluted shareholders to grow its production. But, since the new management team took over last year, the company made a U-turn and prioritized net debt reduction. The strategy consisted of using the extra cash from a dividend cut, a reduced capital program, and some asset sales to decrease the debt load.
Focus on reducing net debt
To strengthen the company's balance sheet, management announced the highly visible decision to slash the annualized dividend by about 89%. Since the beginning of the year, the annualized dividend dropped to only four Canadian cents per share and the dividend yield is now only 0.8%. Also, switching from growth to flat production was a conscious decision to reduce the capital program and increase the free cash flow for net debt reduction. And the results are becoming noticeable.
With these initiatives, and thanks to strong earnings and a significant asset sale announced last week, net debt is forecasted to decrease from 4.4 billion Canadian dollars ($3.34 billion) at the beginning of 2018 to 2.75 billion Canadian dollars ($2.1 billion) by the end of this year.
Crescent Point's priority will still continue to be reducing its debt load due to the challenging environment. A portion of the company's production is exposed to Canadian oil benchmark prices, which are volatile due to infrastructure issues and pipeline restrictions. Management's strategy is prudent, considering the situation and the associated volatility isn't likely to improve anytime soon. For instance, the extension of oil production curtailment in Alberta into 2020 is an illustration of the lack of structural solutions in the short term.
Thus, with this context, management plans to decrease the net debt-to-adjusted funds flow ratio, which demonstrates the ability of the company to pay off its debt with its cash flow, below its current level of 1.7 times.
This ratio at a lower -- and safer -- level means management has been delivering results according to plan. And the need to reduce net debt is becoming less urgent. But the market is still discounting the stock as returns to shareholders in the form of significant share buybacks or dividend increases have yet to materialize.
Low valuation and share buyback
Management did announce a share buyback program in January. But, due to the focus on net debt reduction, the company has repurchased only 1% of its common shares since the announcement. With the debt now at a reasonable level and the extra cash the company received in its recent asset sale, there's reason to expect accelerated buybacks. And with a modest valuation, accelerating buybacks should enhance returns to shareholders.
Management expects about $265 million of free cash flow in 2019 at an average WTI price of $55 a barrel. With the stock price at $3.91, the market capitalization of $2.06 billion corresponds to a free cash flow multiple below eight times. Assuming a WTI price of $60 a barrel, the forecasted free cash flow increases to $417 million and the free cash flow multiple drops below five times.
Even in the context of a modest average WTI price of $55 a barrel in 2019, the market values the company at a low free cash flow multiple. Production is expected to stay flat and management has a few capital allocation possibilities with this excess free cash flow.
A dividend increase should be the least favored option. Given the uncertainties in the current environment, I prefer management to keep on reducing net debt. And the company should also take advantage of its low stock price and repurchase more shares.
Despite the exposure to volatile oil prices, the results from the new management team's decisions are becoming visible. The debt load is diminishing. And the company can to take advantage of its low stock price and repurchase shares. As a shareholder, I will watch that the capital allocation decisions match my preferences for debt reduction and share buybacks over the next several quarters.