Cenovus Energy (CVE -0.19%) delighted its investors with its latest earnings release, posting impressive operational results and announcing it was tripling its dividend.
Normally this would be the highlight of the earnings call in and of itself. But there's even better news here: Cenovus left the door open for more returns to shareholders, and it has plenty of room to comfortably increase the dividend from here.
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The payout
There's an old investing adage: "The safest dividend is the one that was just raised." Management tripled the annual dividend payout from $0.14 to $0.42. This raise comes on the heels of doubling the payout last quarter. Even with this increase, Cenovus still only yields just over 2%.
This lags peers like Suncor Energy (SU 0.31%) and Canadian Natural Resources (CNQ -0.21%), which both pay out north of 3.5%. But I like the fact that management isn't rushing to go all in on the dividend and is leaving itself with flexibility to increase it over time.
CEO Alex Pourbaix stated that the board has approved introducing a potential variable dividend and that the company will also keep buying back shares. Share repurchases benefit shareholders by reducing the number of shares on the market and increasing earnings per share. Buybacks are also a sign that management believes the stock is undervalued.
Pourbaix says that as the company continues to reduce debt, it will target paying out 50% of excess funds toward shareholder returns and that the rest will be devoted to further deleveraging. He says that the company will "continue to execute opportunistically to the extent that our share price remains below intrinsic value at around $60 [for West Texas Intermediate crude]."
Cenovus aims to use most of this for buybacks and will use whatever is left over for a variable special dividend. When the company reaches its goal of $4 billion in debt, it will target returning 100% of the excess funds to shareholders.
As an investor, it is encouraging to see this commitment to shareholder returns. It is also great to see this intelligent and flexible approach. When shares are below where Cenovus sees intrinsic value, the company will use cash flow for share repurchases, and if shares are fairly valued, the rest will be paid out as a special dividend. I like this approach instead of locking the company into a rigid dividend policy and becoming beholden to it.
I also like that Cenovus is being conservative and assuming a price of $45 for West Texas Intermediate (WTI) oil in its calculations. While the prices that Cenovus and other Canadian producers receive for synthetic crude oil are at a discount to WTI, they are still well above the $45 price that Cenovus is using for its plans for capital allocation. For example, during the quarter, Cenovus received a price of about $75 per barrel, and in March, the price for Western Canada Select (WCS) oil averaged $94.57 per barrel.
Is Cenovus a buy?
Alex Pourbaix and Cenovus are using the windfall from elevated oil prices wisely, paying off debt, buying back shares at below intrinsic value, increasing the dividend payout, and leaving room for variable special dividends and further raises in the future. This sets Cenovus up as a compelling dividend growth story over time if oil prices stay above its stated breakeven targets, and shares look like a compelling investment. Cenovus is one of my core positions, and I like the course that management is charting for the company.
