The year 2026 has shown that deeply out of consensus investments in the portfolio have continued to reward investors. Our banks and energy companies continue to lead investment performance as they have over the last three years. While shareholders should enjoy this, we also want to talk about how these companies look versus where we started out with them.
In December of 2020, the portfolio purchased shares in Husky Energy, which had announced a merger with Cenovus (CVE). At that time, the combined company was trading for 40% of the invested capital of the business, a steep discount to replacement. Investors had to be optimistic about where the returns on capital would go, as we were still normalizing from negative oil prices in the spring of that year. You had to hope the business could get to 10% returns on its capital base. If they did, you could hope to expect they would trade at one times capital.
At the end of the third quarter of 2026, Cenovus trades for two times its invested capital. This is a much higher multiple than 2020, but it produces far higher returns on capital now, as well. The analysts who cover the stock think it’s going to provide 25% returns on invested capital (ROIC). At current spot prices of $90 WTI, Cenovus is producing closer to 30% returns. Returns could go down 40% from current levels on lower oil prices and still justify the current two times capital multiple. The shareholder buybacks reinforce that this business deserves to get a premium as they are efficiently allocating capital for shareholders.
We’ve gone from wondering whether the returns on capital would be adequate in the future to attempting to figure out what the right multiple is for those high returns. What a great problem to have! As the business compounds cash and returns it to us, time is on our side. We don’t think the opportunity will be gone until the oil futures curve is in contango and passive owns a double-digit percent in the space. Seems years away to us.
The European banks have followed a similar story. Unicredit (UCG) was looking like a high single-digit return on equity (ROE) company back in the summer of 2022. Their outspoken CEO, Andrea Orcel, was telling investors the stock was cheap and he was going to return capital via buybacks while the stock was less than half of the book value. Rates went higher and stayed. The business became a mid-teens ROE story four years later and has been the stalking horse on other banks over the last two years as they get a nice premium on book value today.
We expect them to close on their purchase of Commerzbank (CBK) in due time and consolidate that unit with their German operations. We then expect them to repeat the process on Alpha Bank (ALPHA) in Greece and/or consolidate more in Italy. Scale is a driver of returns in capital-intensive businesses like banking and energy. Cenovus continues to acquire companies, including the recent acquisition announcement by them of Athabasca.
No one has been dreaming about how bright their future is for these companies. This compares to many of the things that Mr. Market didn’t understand. He didn’t understand that the ECB wants bank consolidation, and there are rewards in liquidity of public indices and the cost of capital for banks that shape that path. Mr. Market also didn’t understand that once the oil sands’ assets began consolidating, it would all go quickly. There are only three oil sands businesses left with scale. We own two of them, Strathcona (SCR) and International Petroleum (IPCO).
We will continue to ask what it is that Mr. Market does not understand in new investments. Autotrader (AUTO), Burberry (BRBY) and West Fraser Timber (WFG) seem to show signs of this. We will be patient as we await Mr. Market to recognize all that the investors of the strategy have figured out already.
Here’s to playing the long game,
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The information contained herein represents the opinion of Smead Capital Management and is not intended to be a forecast of future events, a guarantee of future results, nor investment advice.
Smead Capital Management, Inc.(“SCM”) is an SEC registered investment adviser with its principal place of business in the State of Arizona. SCM and its representatives are in compliance with the current registration and notice filing requirements imposed upon registered investment advisers by those states in which SCM maintains clients. SCM may only transact business in those states in which it is notice filed or qualifies for an exemption or exclusion from notice filing requirements. Registered investment adviser does not imply a certain level of skill or training.
This newsletter contains general information that is not suitable for everyone. Any information contained in this newsletter represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. SCM cannot assess, verify or guarantee the suitability of any particular investment to any particular situation and the reader of this newsletter bears complete responsibility for its own investment research and should seek the advice of a qualified investment professional that provides individualized advice prior to making any investment decisions. All opinions expressed and information and data provided therein are subject to change without notice. SCM, its officers, directors, employees and/or affiliates, may have positions in, and may, from time-to-time make purchases or sales of the securities discussed or mentioned in the publications.
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