Eric Nuttall, partner, senior portfolio manager, Ninepoint Partners
FOCUS: Energy stocks
Top Picks: Baytex Energy, Nuvista Energy, Precision Drilling
MARKET OUTLOOK:
With oil trading firmly over US$80 West Texas Intermediate and the S&P/TSX Capped Energy Index roughly matching the Nasdaq and quadrupling the broader TSX year-to-date, it is perplexing that sentiment towards the space remains so challenged. Investors are morose even though stocks are working, and it is time for a reality check. Energy companies are generating record free cash flow at current prices, are actively buying back stock, and increasingly returning more and more of free cash flow back to investors. At the current oil price, several companies will return over 90 per cent of the current market cap back to investors in the form of buybacks and dividends over the next five years. We would be challenged to find another sector that offers such compelling returns while also offering free optionality on higher prices in the years ahead for both oil and natural gas.
Given the delta between improving oil prices and energy equities, we find the best opportunities in Canadian oil companies with decades’ worth of stay-flat inventory. These companies are trading at 11-14 per cent free cash flow yields and returning or set to return 100 per cent of free cash flow back to investors. As the challenges facing U.S. shale companies become more obvious to the masses, we believe Canadian oil companies will trade at a premium to U.S. peers, especially with a change in government late next year.
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TOP PICKS:
At US$80WTI Baytex is set to return 95 per cent of its current market cap back to investors in the form of share buybacks and dividends over the next five years despite having an estimated 13 years of stay-flat inventory. Generating $765 million of free cash flow and returning half of it back to shareholders in the second half of this year, the company is set to retire 10 per cent of its shares outstanding in the next six months. Despite poor performance over the past year, we are sticking with the stock, believing that a 29 per cent free cash flow yield and 2.4 times trading multiple are sharply disconnected from fair value
Over the next several years Nuvista will grow production from 85,000 barrels of oil equivalent per day (boe/d) to 120,000 boe/d, and then keep production flat for 20-25 years. Returning 75 per cent of its free cash flow now we see this increasing to 100 per cent in a few years time, thereby increasing annual shareholder returns from 11 per cent currently to over 20 per cent. Trading at three times EV/CF despite having decades worth of inventory, we think fair value today should be five times EV/CF = 10 per cent FCF yield = $22.50 target price = > 60 per cent potential upside.
Despite sluggish oilfield service activity levels currently Precision is rapidly harvesting free cash flow, paying down debt, and returning over 30 per cent of its free cash flow back to shareholders. We are bullish on an increase in natural gas and oil activity in 2025 and have the stock trading at a 23 per cent / 26 per cent 2024/2025 free cash flow yield. Given non-depleting assets we think a 13% free cash flow yield approximates fair value = five times EBITDA = $191 target price = 107 per cent potential upside.
| DISCLOSURE | PERSONAL | FAMILY | PORTFOLIO/FUND |
|---|---|---|---|
| BTE TSX | Y | Y | Y |
| NVA TSX | N | N | Y |
| PD TSX | N | N | Y |
PAST PICKS: August 23, 2023
Cenovus (CVE TSX)
- Then: $25.55
- Now: $26.26
- Return:3%
- Total Return: 6%
VEREN (VRN TSX)
- Then: $11.05
- Now: $10.55
- Return:-5%
- Total Return: -0.3%
Athabasca Oil (ATH TSX)
- Then: $3.68
- Now: $5.11
- Return:39%
- Total Return: 39%
Total Return Average: 15%
| DISCLOSURE | PERSONAL | FAMILY | PORTFOLIO/FUND |
|---|---|---|---|
| CVE TSX | N | Y | Y |
| VRN TSX | Y | N | Y |
| ATH TSX | N | N | Y |
