Anchoring bias is a hell of a bias. But being fully aware of this bias, I can discount the fact that we recommended MEG Energy as our 2nd largest position in March 2020 after the CRC debacle.
And yes, we recommended this name when it was $1.22 CAD. It’s not a typo.
While the March 2020 analysis focused on how the company would survive falling oil prices, the analysis we offer today is the exact opposite.
MEG Energy is one of the few power producers in the market today without hedging exposure. Yes, zero hurdles. Unlike Baytex Energy Corp. (OTCPK:BTEGF), which likes to protect against upside risk, MEG takes it literally for the champion that it is. And based on our free cash flow estimates, taking the risk will pay off big for MEG.
At $105/bbl WTI, MEG could generate up to C$1.7-1.9 billion of free cash flow. The wide range depends on the differential it receives for its oil.
With a market capitalization of C$5.442 billion, MEG trades at ~3x FCF or ~33% FCF yield.
On a DCF basis at a price of $90/bbl WTI, MEG is worth 3.5 times what it is trading today.
Now, of course, much of this analysis depends on how well the price of oil performs, but the fundamental analysis aspect of oil could be considered in just about any other MFO.
In MEG’s year-end earnings report, he updated this slide on what he plans to do with free cash flow.
What’s crazy about this chart is that in the current oil price environment, MEG will be below ~C$1.7B by the May release date. This means MEG will likely announce NCIB in its Q1 report, which should be very supportive for the stock. By the end of the year, MEG will have less than C$1 billion in debt and more cash will be returned to shareholders. We might even see a dividend being paid later.
All of this will result in a major global problem for MEG. What’s also particularly interesting about MEG is that he also has a kind of identity crisis.
Back in 2018, when we were first long in MEG, Husky made an offer to buy it for around C$10 per share. The company refused and the oil market crashed. Husky himself was bought by CVE.
The reason MEG is an attractive acquisition target is that it’s too small to be considered a scalable oil sands producer, while it’s not big enough to buy others.
MEG has Tier 1.5 to Tier 2 assets, making it very attractive for a large oil sands producer with scale to digest. The only real suitable buyers would be CVE or SU. Neither is looking for acquisition targets at this time, but never say never. Then there’s Imperial Oil (IMO), largely owned by Exxon (XOM), which won’t be doing any transactions anytime soon.
All of this leaves us with the big Goldilocks scenario in the next 2-3 years. MEG will make a lot of money, shareholders will get their fair share and MEG will eventually be bought out in the future.
A great win-win-win scenario for shareholders.
Why did we buy MEG today? Because it is trading at a free cash flow yield of around 33% and no hedging is in place, MEG is fully pulled up. The debt that has bogged down MEG’s valuation in the past will no longer be an issue by the end of the year. Buy MEG is our 2nd largest position.