Eric Nuttall’s Top Picks for September 13, 2024

Eric Nuttall, partner and senior portfolio manager, Ninepoint Partners

FOCUS: Energy stocks

Top Picks: MEG Energy, Tamarack Valley Energy, Freehold Royalties

MARKET OUTLOOK:

Oil has sold off violently over the past several weeks to levels far below what fundamentals would suggest. Yes, Chinese demand has been especially weak with growth the lowest in 15 years (ex-COVID-19), however, this has been true for several months. We believe that while the financial demand for oil is weak, as evidenced by net speculative length at its lowest level in history, global physical demand remains okay, though admittedly growing less than originally hoped.

On supply, U.S. shale has been flat for eight months and is forecasted by Rystad to be flat for another nine months resulting in flat year-over-year growth by November. OPEC+, under the leadership of Saudi Arabian Energy Minister Prince Abdulaziz bin Salman, is applying tremendous pressure to Iraq, Kazakhstan, and Russia to improve compliance rates to their deal to voluntarily remove barrels from the market and this is showing recent progress.

With global oil inventories at or near their lowest levels on record, OPEC+ is intent on preventing contra-seasonal inventory builds and will wait for its barrels to be pulled from it, U.S. shale which has been the largest source of short-cycle supply not growing.

Additionally, oil and gas companies are entering the 2025 budget season with a weaker-than-expected oil price, so we think fundamentals are stronger than what is shown in the paper market for oil.

We think we are past the point of capitulation and that energy stocks represent compelling value. Energy stocks have sold off by more than 10 per cent in recent weeks, now dividend-yielding four to eight per cent, free-cash-flowing on average 10 per cent at current pricing, and able to sustain dividends and maintain flat production at US$45-$55 West Texas Intermediate (WTI).

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TOP PICKS:

MEG ENERGY (MEG TSX)

MEG Energy is likely weeks away from beginning to return 100 per cent of free cash flow back to shareholders in the form of buybacks. With 35 years of stay flat inventory and trading at an 11 per cent/16 per cent free cashflow yield at $70/$80WTI, we believe the stock to be mispriced. Our target is $39.30 which is 6.5 times 2025 EV/CF or a 10 per cent free cashflow yield at $80 WTI.

Tamarack Valley Energy (TVE TSX)

Owing to its extremely profitable wells in the Clearwater, TVE can cover its four per cent dividend and keep production flat at $49 WTI ($42 with current hedges) offering a high degree of safety in a volatile tape. Trading at 3.7 times/3.2 times EV/CF at $70/$80 WTI and a 13 per cent/19 per cent free cash flow yield, we think the company’s inventory of 20 years of stay-flat Clearwater inventory is being mispriced, with a fair value closer to five times EV/CF = $5.66/$6.80 at $70 WTI/$80 WTI.

Freehold Royalties (FRU TSX)

Yielding 8.2 per cent sustainable down to $55 WTI and with 10-15 years of stay-flat inventory, Freehold is trading at the same multiple of a traditional E&P business despite having the advantages of being a royalty company. While a sleepy name lacking an immediate rerate catalyst, we think the potential for renewed growth on its U.S. acreage given two-thirds of its Permian acreage now lies with Exxon and Diamondback is being overlooked. With its close peers trading at twice the valuation, we think the stock is undervalued and should be benefitting like infrastructure and utility stocks by lowering interest rates.

PAST PICKS: SEPTEMBER 29, 2023

Cenovus Energy (CVE TSX)

• Then: $28.28
• Now: $22.10
• Return:-22%
• TotalReturn: -19%

Athabasca Oil (ATH TSX)

• Then: $4.35
• Now: $5.16
• Return:19%
• Total Return: 19%

Veren (VRN TSX)

• Then: $11.26
• Now:$8.61
• Return:-23%
• Total Return: -20%

Total Return Average: -7%