Eric Nuttall’s Top Picks for August 16, 2024

Eric Nuttall, partner and senior portfolio manager, Ninepoint Partners

FOCUS: Energy (oil & gas, services) stocks

Top Picks: Tamarack Valley, Nuvista, ARC Resources

MARKET OUTLOOK:

Energy is the top performing sub-index in Canada year to date (YTD), has created generational wealth for some over the past four years, and is supported by ongoing constructive fundamentals, yet remains a contrarian investment. This is perplexing. Despite (once again) recessionary worries and obvious weakness in Chinese diesel demand, oil demand remains “fine,” up about 1.2 million Bbl/d. “The real story is on supply: U.S. shale production growth is imploding while OPEC+ is unlikely to begin to return curtailed volumes in October as advertised given its propensity for being “preemptive, proactive, and precautionary” and its ability to stay nimble to market vagaries.” Even assuming the full return of OPEC+ barrels as advertised, which is not our base case, we believe oil has a fundamental floor of around US$80 West Texas Intermediate (WTI) given that “days of supply” of global oil inventories will stay below normal levels.

With each passing month, more companies are hitting their final debt targets and pivoting to higher “return of capital.” The norm now is 75-100 per cent of free cash flow being returned back to shareholders, primarily in the form of share buybacks. Any misbelief that companies are not “walking the talk” is misplaced, and there is a strong correlation between share buybacks and positive price performance. We continue to favour Canada over U.S., oil over natural gas, and midcap over large cap, and continue to add to names which by our estimates at $80 WTI and $3.50 NYMEX are trading at 14 per cent-26 per cent free cash flow yields.

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TOP PICKS:

Tamarack Valley (TVE TSX)

Tamarack is officially out of our dog house, having met or beat expectations for two quarters in a row. Continued deleveraging has allowed it to recently increase shareholder returns to 60 per cent increasing to 75 per cent by the end of next year. It is trading at an 18 per cent free cash flow yield at $80WTI/$3.50 NYMEX. We see the combination of share buybacks plus modest production growth leading to a re-rating from the current forward multiple of 3.3 times closer to five times = $7.00/$8.30 one/two-year price target = 72 per cent/106 per cent potential upside at $80WTI.

Nuvista (NVA TSX)

Nuvista is growing production from 85,000boe/d to 120,000boe/d by 2027 at which point it has the inventory depth to keep production flat for 20-25 years. Trading at a 2025/2026 FCF yield of 11 per cent/16 per cent and returning 75 per cent of free cash flow back to shareholders, we see the compounding effect of meaningful share buybacks compressing its trading multiple and forcing a re-rating closer to five times. Our one and two-year target is $20.60/$26.70 = 53 per cent/99 per cent potential upside.

ARC Resources (ARX TSX)

ARC Resources offers deep inventory depth with over 20 years of premium inventory depth and four to five equivalents of their current Attachie development area plus long-term leverage to a secular bull market in natural gas. Trading at 4.5 times EV/CF and returning 70 per cent of post-dividend free cash flow to returns, we see visibility for ongoing trading multiple compression from ongoing, meaningful share buybacks.

PAST PICKS: SEPTEMBER 29, 2023

Cenovus Energy (CVE TSX)

• Then: $28.28
• Now: $27.03
• Return:-4%
• Total Return: -2%

Athabasca Oil (ATH TSX)

• Then: $4.35
• Now: $5.62
• Return:29%
• Total Return: 29%

Veren (formerly Crescent Point Energy) (VRN TSX)

• Then: $11.26
• Now: $10.01
• Return:-11%
• Total Return: -8%

Total Return Average: 6%