Oct 21, 2016

Dennis da Silva's Top Picks: October 21, 2016

BNN Bloomberg

Dennis da Silva , BNN

Dennis da Silva, managing director and senior portfolio manager at Middlefield Capital Corporation

Focus: Canadian resource stocks
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MARKET OUTLOOK
We continue to be constructive on energy markets over the medium and long term. Fundamentals for crude oil have set the stage for a more balanced energy market into 2017, while natural gas offers more near-term price appreciation potential. The preliminary OPEC agreement reached at Algiers may finally be the line in the sand, marking a bottom for crude. The agreement’s details will not be finalized until the formal OPEC meeting in November, although the headline of a potential agreement is a step in the right direction. We see additional price-appreciation potential for natural gas but remain cognizant of short-term variables such as weather, coal-to-gas switching and regional price discrepancies.

Looking forward, we continue to favour zinc over other fundamentally oversupplied commodities such as copper, nickel and iron ore. The closure of western zinc mines and Glencore’s unexpected announcement to cut production has finally led to the market’s recognition that the zinc market will rebalance in 2017. Despite some of the best performances year-to-date, we believe that zinc prices will continue to be well supported as the physical market moves towards a significant deficit in 2017.

Beyond the strength of precious metals prices, the industry’s cost-cutting program over the last several years has led to margins rising faster than the underlying precious metals prices. With the balance sheet of gold producers greatly improved and margins near peak levels as gold trades near the top end of our price range, we expect companies with organic growth to begin to outperform.

TOP PICKS

HORIZON NORTH LOGISTICS (HNL.TO)
This $240 million market cap company is known for its oil and gas camps and catering business, but organic growth will be in non-energy, modular solutions. They recently won a contract with the Vancouver Affordable Housing Initiative. HNL is moving the business forward even in a challenging energy environment with specialized managers now in place for the manufacturing and supply chains. This company is well situated to take advantage of more pre-fabricated development opportunities that exist across industries. Cheap valuation with great balance sheet to finance new initiatives. EPS growth expected to be 14 per cent per share.

LEUCROTTA EXPLORATION INC. (LXE.V)
Emerging Montney player that is extending the NE B.C. Montney trend north with delineation drilling, which should grow net asset value significantly over the next couple of years. Directly north of Arc and east of Tourmaline activity, which also helps de-risk their play. This was a spin out from Crocotta in 2014. Management has a history of monetizing assets and they own 16 per cent of the company on a fully-diluted basis. After 2017, they will start to focus on cost improvements and efficiency, ultimately through pad drilling to drive economics. Key catalysts are their plan to tie-in four wells in Q4/Q1 2017 after infrastructure is built, and also to drill two horizontal wells and one vertical well. This will take current production of 1,000 BOE/D to 3,000 to 4,000 BOE/D in the near term.

TREVALI MINING CORP (TV.TO)
This is a unique way to play the zinc market given it is essentially a pure zinc producer. Production comes from one mine in Peru and another in New Brunswick. Recent strength has been on the back of strengthening zinc prices and commercial production from its new mine in New Brunswick. The timing could not be better as zinc fundamentals should tighten up through 2017 due to declining western mine supply and stable demand. Expansion at both mines should see production double by 2020 to almost 300 million pounds. Peru operations are a joint venture with Glencore, who also owns eight per cent of the stock and has provided debt facilities in return for offtake.