Ovintiv Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Ovintiv is a North American oil and gas exploration and production company focused on developing high-quality multi-basin portfolios of oil, NGLs, and natural gas, using unconventional extraction methods.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Ovintiv operates in a notoriously competitive industry, where barriers to entry are relatively low for many players, and high volatility from commodity prices. Therefore, its moat is fragile and very susceptible to changes in prices and demand.

Moat Assessment: 3 / 5

Limited Moat: Ovintiv’s economic moat is considered narrow due to the commodity nature of its products (oil, NGLs, and natural gas), meaning they can’t differentiate themselves from their competitors. The company relies primarily on efficiency to generate profits.
Cost advantages: Ovintiv does have some cost advantages due to technological innovation in the production of oil and natural gas from unconventional shale formations. These efforts allow them to produce oil and gas at lower cost relative to their competitors and to improve efficiency in the process, but technological advantages can disappear rapidly in the oil industry.
No Pricing Power: As a commodity producer, OVV has no power over pricing as the prices of its products depend on the supply and demand. Therefore, they have limited power over the profitability of their products and limited pricing power in the markets.
Scale is not a key differentiator: Because oil and gas are globally traded commodities, scale is not an advantage to compete in the market. The advantages from scale in production and efficiency will accrue to all players in the market that are efficient and have enough scale to execute. Therefore, this is not a differentiator for OVV compared to its peers.

Risks to the Moat and Business Resilience

Commodity Price Volatility: OVV’s profitability is highly dependent on volatile commodity prices. A sharp and sustained decline in oil and gas prices could significantly impact the company’s earnings and free cash flow, making its assets less valuable and could even lead to them writing down the assets. Furthermore, it can negatively affect its access to capital and ability to refinance debt.
Geopolitical Risks: As a commodity producer, geopolitical events (such as war, embargos, or regulations) have direct consequences on the prices of oil and gas and indirectly, on the volumes they can supply. They can also impact their cost of production or reduce the demand.
Environmental Regulations: As an energy company, regulations can hurt their profitability and access to resources. Regulations regarding greenhouse emissions, methane emissions, and waste disposal can impact future profitability and costs.
Competition: The oil and gas market is highly competitive, with many players vying for market share. Competitors’ innovations can reduce Ovintiv’s technological advantages, and price wars or excessive capacity can make profits low or even nonexistent.
Economic Slowdowns: During recessions, there is reduced demand for products and services, including oil and natural gas. Therefore, the company can experience lower revenues and profitability during recessions.
Technological obsolescence: Newer production techniques (such as hydraulic fracturing) can lower the cost of competitors or open up production in new fields at a lower cost, therefore, decreasing Ovintiv’s profitability.
Lack of Access to Capital: Although most companies in the oil and gas market can have large quantities of reserves and produce as much as they desire, they are highly dependent on capital to fund exploration and expansion activities. If their credit rating is downgraded (which can happen in periods of high debt or low revenues), the company will lose the ability to borrow and raise capital.

Business Explanation

Revenue Distribution: Ovintiv’s revenues are derived from the sale of oil, NGLs, and natural gas produced in its assets in the U.S. and Canada. Most of their production and sales come from the U.S. operations.
Industry Trends: The oil and gas industry is currently characterized by volatility due to geopolitical factors and a transition toward renewable sources of energy. There is heavy scrutiny regarding the environmental footprint of oil and gas producers with many regulations proposed to decrease this, and consumers are becoming more mindful of the environmental implications of the energy they use. Furthermore, there is more demand for long-term sustainable energy production and increased awareness among investors towards investments that are in line with ESG principles.
Competitive Landscape: OVV operates in a very competitive industry with a large number of large players and smaller independents. To stay competitive, OVV must constantly try to cut costs and adopt new and cost-efficient technologies. The market is also dominated by larger players with more capital and resources to use, hence OVV’s smaller size is a disadvantage.
What Makes OVV Different: OVV is committed to reducing environmental impact through continuous innovation and a low-cost structure. This can allow the company to generate more value than its peers and be well positioned for the future when demand for cleaner energy sources becomes more prevalent.
Other relevant information: While many sources of energy are becoming more prevalent, oil and natural gas remain critical resources for the future. Therefore, the demand for oil and natural gas is still going to remain stable and possibly even increase for the coming years. Therefore, if a company can produce energy in an economic and efficient manner it may be well positioned for the future even with competition.

Financials In-Depth

Reorganized Financial Statements: In order to properly measure performance, the financial statements need to be reorganized. Therefore, we will focus more on the NOPLAT instead of net income, we exclude financing and nonoperating activities from operating activities to get a more clear view of the profitability of core operations. Also, noncash expenses like depreciation and amortization should be included in operating expenses.
Historical ROIC: Based on the data from the latest 10k report, we calculated ROIC for OVV from 2019 - 2022. We used a three-year average for the invested capital in the ROIC formula. During 2019, OVV made a low return of 4.3 percent, followed by a poor ROIC of negative 5.9 percent in 2020 due to COVID. Then, there was a big turnaround with a return of 17.1 percent in 2021 and finally, 23.8 percent in 2022. This shows that although the oil and gas industry was doing well in the last couple of years, the company’s ROIC can vary significantly with the volatile environment of the industry and its high dependence on prices of oil and natural gas.
Debt Levels: In their recent reports, they show a long-term debt of 4,935 million which has remained somewhat stable through the last year. The company’s strategy is now focused on debt repayments and they will likely use excess cash flow to pay off debt. Although the debt is not unmanageable and they have been paying it off, high debt makes them more risky than others with low debt.
Capital Investments: For 2022, the company reported capital expenditure of 2,088 million, which is a big jump from 1,097 in 2020, and 1,518 in 2021. The spending on capital expenditure is driven by their focus on efficiency, higher drilling, and production rates.
Current Assets and Liabilities: Their current assets of $5.8 billion and current liabilities of $3.1 billion is very strong, and provides a lot of liquidity for the company.

Note that the company has an “asset retirement obligation” of more than 4.8 billion. The value of these obligations are discounted back to the present, and it must be assumed that it will take a lot of time and capital to properly retire these assets. This can become very costly if regulations become more harsh, if the required technology becomes more expensive, or if future estimates are wrong.

Understandability: 2 / 5

The oil and gas business can be very complicated to understand due to its dynamic nature. Also, to have a deep understanding of the company, it would require a specialized financial understanding to parse through the reports, and knowledge of geology and oil and gas production.
It would not be easy for a non specialized person to understand why the company may be generating profit at this level given the prices of oil, and to analyze what their plans might entail in the future.

Balance Sheet Health: 4 / 5

Positive Assets to Liabilities Ratio: OVV’s balance sheet is generally healthy with positive current assets to liabilities and low-to-moderate level of long-term debt. Therefore, the company is able to meet its obligations, and has little chance of immediate bankruptcy.
Debt Repayments: As stated earlier, their debt is not unmanageable and they are focused on reducing it, which adds to their safety as a going concern.
Intangible Assets: OVV also has substantial amounts of intangible assets like goodwill and others. This may hide some of the poor performance of their investments or past acquisitions. However, if these goodwill accounts are properly maintained, they should be a proper representation of the true value of their nonphysical assets.
Liability of Asset Retirement Obligations: The company’s significant liability associated with asset retirement and obligations can be concerning if not properly managed, and if not reflected in free cash flows.
Lack of Equity: The value of equity is almost half of the value of their total assets, meaning the business relies on debt more to keep itself alive. However, their low leverage (net debt/net asset ratio) makes this point less of a concern.

Recent Concerns, Controversies, and Problems

Inflation and Operating Costs: The company’s financial results are heavily affected by inflation and increasing operating expenses. Their profitability will depend on how they are able to keep costs down while facing pressures from inflation.
Alberta Production Regulations: New legislation in Alberta has proposed to slow production by 3 percent in early 2024. This legislation is likely to hurt the revenues from their Canadian operations.
Lower Oil Prices: The latest reports show a drop in prices of oil. This can cause the company’s revenues to lower in the next quarters unless production levels are very high. It’s important to see how they will navigate this change in commodity pricing.
ESG Pressure: OVV needs to continue focusing on environmental initiatives and their ESG scores, and this will continue to be an important part of their growth strategy. Failure in focusing on ESG ratings can cause a decline in investor interest and cause a decrease in valuations.

Management Outlook:

They will be focusing on production increases to take advantage of current high prices and meet the demand for oil and natural gas.
They are continuing to pursue their strategy of lowering their debt levels, which means they will likely be in a stronger position in the future.
They are focusing on cost reductions and operational improvements in order to offset higher operating costs.
They claim to be pursuing a culture of operational excellence with a focus on safety.
They continue to monitor the macroeconomic environment for any sudden changes that may impact the company’s valuation.
Their long-term goal is sustainable profitability and to increase share value by leveraging their asset base and operations.

In conclusion, OVV has a narrow economic moat because it operates in a highly competitive industry, but their ability to create and maintain a cost advantage can give them an edge. Due to this and their debt reduction strategy, it can be considered a moderately investable company, with a reasonable degree of financial stability and low enough debt levels, but can fluctuate drastically depending on macroeconomic conditions and changes in the oil and gas market.