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A 3.7% Yield at an Exceptional Price

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Note From Contributing Analyst Jody Chudley: Welcome to the debut of The Value Meter, Wealthy Retirement‘s new weekly column!

Each Friday moving forward, I will use The Value Meter column to evaluate an individual stock to determine whether its valuation is attractive.

And I’ll be using an easy-to-understand grading scale for you to follow…

Ranging from good to bad, The Value Meter’s grading scale will slide from “Extremely Undervalued” to “Slightly Undervalued,” “Appropriately Valued,” “Slightly Overvalued” and “Extremely Overvalued,” in that order.

Think of The Value Meter as the sister column to Wealthy Retirement‘s Safety Net, which vets the dividend safety of stocks each Wednesday.

And just like Safety Net, in upcoming Value Meter columns, I’ll be looking to you for suggestions of which companies to cover. So please submit the company you’d like me to cover in the comments section of this article.

Why focus on valuation?

Because nothing dooms or benefits an investment right off the bat quite like your entry valuation – even if the stock’s business is flourishing and the dividend is safe.

But homing in on attractive valuations entails looking at the full picture – no small feat.

Fortunately, I’ve dedicated my life to developing 360-degree views of stocks… and each week, I’m going to teach you over time how to more appropriately value stocks on your own time…

So what are we waiting for?

Let’s jump to it!


On October 5, 2021, I called Cenovus Energy (NYSE: CVE) insanely cheap.

Shares of Cenovus were then offering a ridiculous 27% free cash flow yield.

My only mistake was not pounding the table louder on this stock.

Since October, Cenovus shares have more than doubled.

Chart: Cenovus Energy Share Price
Yes, we did have some luck here. Oil prices have soared on tightening supply and demand fundamentals, thanks in part to Russia’s invasion of Ukraine.

But war or no war, this was a wonderful buying opportunity. We were looking at an incredibly attractive valuation on this world-class company, as both oil production and supplies were falling and demand was roaring.

My oil play had (and still has) plenty of macro-level tailwinds behind it. The supply-demand fundamentals are getting tighter by the week and show no sign of relenting. I believe we are looking at multiple years of strong oil prices.

That is why, today, I’ve got my eyes set on another Canadian oil producer that’s every bit as cheap as Cenovus was last October.

A Free Cash Flow Machine

At current oil prices, Canadian Natural Resources (NYSE: CNQ) is essentially printing cash.

The company is projected to generate more than $20 billion in free cash flow in 2022 alone should oil prices stay above $100 per barrel. Given oil is trading at $120 per barrel today, that free cash flow figure looks conservative.

Meanwhile, Canadian Natural’s total market valuation (market cap plus total debt) is currently hovering around $80 billion.

So we have a company valued at $80 billion, and it’s conservatively generating $20 billion in free cash flow. That equates to a free cash flow yield of 25%, which almost exactly matches what Cenovus was offering last October.

As I’ve said many times before, free cash flow is the holy grail of investors.

It’s the excess cash flow that a business throws off after it has invested in growth opportunities.

Free cash flow can be used to pay down debt, repurchase shares or pay a dividend – or all three, as Canadian Natural is doing.

The dividend yield is also strong at Canadian Natural’s current share price.

With the most recent quarterly dividend of $0.59 per share, Canadian Natural is yielding almost 3.7%.

On top of that, the company’s share repurchase program is rewarding shareholders.

Year to date, Canadian Natural has already repurchased $1.5 billion worth of shares.

But here’s the best part…

The company has used its remarkable free cash flow generation to completely transform its financial position for the better. Canadian Natural’s cash flow-to-debt ratio has dropped from 4 at the start of 2020 to just 0.4 today!

That’s a 90% reduction in total leverage, which leaves Canadian Natural in an incredible financial position.

Chart: Canadian Natural Resources Cash Flow-to-Debt Ratio
All in all, this is a wonderful free cash flow story…

But I’ll leave you with one more convincing valuation metric…

For each barrel of oil that Canadian Natural has, investors are currently paying just $7.

In a world where oil is trading for more than $100 per barrel, that’s an incredible price.

And so long as the price of oil remains the same or increases, Canadian Natural shares will remain incredibly cheap.

If you believe that high oil prices are here to stay, this stock is a no-brainer.

And if you just want a hedge against rising oil prices, Canadian Natural’s extraordinary free cash flow is also a great option.

I rate Canadian Natural Resources as “Extremely Undervalued.”

Valuation Rating: Extremely Undervalued

The Value Meter
If you have a stock whose valuation you’d like me to grade, leave the ticker in the comments section.

You can also check to see whether I’ve written about your favorite stock recently. Just click on the magnifying glass on the upper right part of the Wealthy Retirement homepage, type in the ticker symbol and hit enter.

Good investing,

Jody

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