Eric Nuttall, Partner and Senior Portfolio Manager, Ninepoint Partners
FOCUS: Energy values
MARKET OUTLOOK:
Despite lingering worries of a recession and the potential negative impact on oil demand, we believe energy investors are positioned for further gains by year-end and into 2023. The largest release of strategic stocks in history is set to end in just over two months. This coincides with an EU embargo on Russian oil imports and the use of EU tankers to transport Russian crude in early December, which could potentially impact Russian production by up to 1 million barrels/d. Even with the massive SPR release and China’s ongoing COVID-zero policies impacting oil demand by around 0.5MM Bbl/d, global inventories have continued to decline throughout this year. . What will happen in a few months when SPR exits end, Russian production is finally hit by sanctions, the European switch from gas to oil comes into effect and Chinese demand finally normalizes due of the relaxation of the COVID-zero policy?
The tenets of our multi-year thesis on the oil bull market remain in place. Oil demand remains largely unresponsive to the slowing economy and will increase for at least the next 10 years. US shale production, constrained by the need to prioritize share buybacks and dividends over growth, has disappointed this year and could be close to peaking. OPEC has largely exhausted its spare capacity and the global supermajors are facing a decade of stagnation due to the eco-awakening. We believe the fundamentals support a US$100 West Texas Intermediate oil price today.
West Texas Intermediate and oil will trade at a “higher” price, around US$100-120+/bbl, for the next six years or more.
Energy companies are nearly debt-free, generating free cash flow, committing to little or no growth and expected to return more than 20% to shareholders in the form of share buybacks and variable dividends in 2023, while trading low almost generational valuations. We remain optimistic.
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TOP CHOICES:
MEG Energy (MEG TSX)
MEG’s investment thesis is simple: 35 years of stable inventory trading at <3X EV/CF at US$100 WTI and the ability to go private with just three years of free cash flow. The company is expected to meet its next leverage target soon to allow 50% of FCF to be allocated to shareholder returns and we expect that by the end of next year the company will be using 100% of its cash flow cash available for share buybacks. We think the fair value is 6X EV/CF = $41/share = 127% upside potential.
Tamarack Valley (TVE TSX)
Tamarack has been an aggressive consolidator in Clearwater gambling, now becoming Clearwater’s largest public company which is the lowest cost gambling in North America. It trades at a below market multiple of 2.3x EV/CF despite having a top percentile game economy and a free cash flow yield of 42%. We believe the company can deliver quickly by allowing 50% of free cash flow to be allocated to shareholder return by Q2 2023. We believe the fair value is 5X EV/CF = 11.50 $/share = 164% upside potential.
Baytex Energy (BTE TSX)
Baytex offers significant exposure to the Clearwater area as well as very economical conventional heavy oil production. Trading at just 1.8X EV/CF and a free cash flow yield of 39%, we believe the company will meet its final leverage target in Q3 2023, allowing 75% of free cash flow to be returned. to shareholders in the form of redemptions. We think the fair value is 5X EV/CF = $19/share = 186% upside potential.
PAST CHOICES: November 5, 2021
Cenovus (CVE TSX)
- So: $15.59
- Now: $26.15
- Return: 68%
- Total yield: 70%
Athabasca Oil (ATH TSX)
- So: $1.24
- Now: $2.41
- Return: 94%
- Total yield: 94%
Arc Resources (ARX TSX)
- So: $12.87
- Now: $18.42
- Return: 43%
- Total return: 47%
Average total return: 70%
CVE TSX | NOT | Yes | Yes |
ATH TSX | NOT | NOT | Yes |
ARX TSX | NOT | Yes | Yes |
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