Eric Nuttall, partner and senior portfolio manager at Ninepoint Partners
Focus: Energy stocks

MARKET OUTLOOK

The COVID-19 outbreak has paralyzed the global economy, resulting in oil demand falling by the greatest amount in history (estimated to be down about 26 million barrels per day currently). Compounding the impacts of the demand shock has been the squabble between Saudi Arabia and Russia that resulted in the breakdown of the OPEC+ agreement and the Saudis surging “production” by over 2 million bbl/d. This has resulted in the oil price falling by as much as 60 per cent and many global benchmarks falling below cashflow break-even levels for producers, resulting in forced shut-ins (Canadian production could fall as much as 1 million bbl/d) as well as historic cuts to capital spending (global capex is down $90 billion so far this year). Year-to-date energy stocks have been crucified, falling by as much as 90 per cent in a matter of months. Will this soul-sucking experience ever end?

For those who can withstand the volatility, energy stocks offer the potential for multi-bagger upside. The demand shock from COVID-19 will eventually pass and structurally we are entering into a very tight future for oil supply. Global offshore is entering into a period of multi-year plateau/declines due to years of insufficient investment (which will only get worse as companies like Royal Dutch Shell cut spending this year by a further $4 billion). U.S. shale has been mortally wounded and is unlikely to ever grow by more than 200,000 or 300,000 bbl/d ever again. We believe that oil can rally into the $50s or higher in 2021 and significantly higher in 2022 and beyond as the world gets hit by a supply crisis. Patience and a stomach of steel is required, but energy stocks were already trading at historically low valuation levels coming into 2020, and now they have fallen by 70 per cent. This too shall pass.

TOP PICKS

MEG ENERGY (MEG TSX)

MEG has one of the highest quality oil sand assets in Canada and has 55 per centof their 2020 production hedged at $59 WTI. The current enterprise value is $3.6 billion and under normalized oil prices (2021) the business can generate $700 million of free cash flow (19 per cent free cash flow yield) on 33 years of proved reserves. With the share price down 68 per cent year-to-date, the market is clearly not giving any value for the defensiveness of their 2020 hedge book. Under a normalized oil price ($50 WTI in 2021), MEG could get back to $6 (vs. $2.36 currently) and potentially up to $9 on a takeout.

NUVISTA ENERGY (NVA TSX)

Nuvista is a natural gas and condensate producer that has fallen by 84 per cent year-to-date despite having 36 per cent of its liquids hedged at C$76 per barrel and a further 24 per cent of it getting an $11 barrel premium to WTI. Even at $30 WTI average this year (strip is $32) we have Nuvista only burning through $69 million of cash resulting in an exit 2020 debt to cash flow multiple of 3.8 and being only 71 per cent drawn on their bank lines. This is an example of a name that has been priced for bankruptcy yet has the liquidity and hedge book to get them through the storm, allowing them to come through the other side and get re-rated. Given the quality of Nuvista’s assets (they raised 4 times their market cap in August 2018 to buy one asset from Cenvous at a share price 14 per cent higher than their current one), we believe Nuvista offers multi-bagger potential.

CENOVUS ENERGY (CVE TSX)

While Cenovus is completely unhedged on their oil production (just like every other Canadian large cap) and no longer materially benefits from their refineries (current margins are close to break-even), the company has the liquidity to allow them to weather the storm. At $30 WTI for 2020, Cenovus would burn through $1.1billion of cash on available credit lines of $4.5 billion. Given the share price has collapsed by 74 per cent, we believe the stock is fully discounting a doomsday scenario (no global oil demand pickup for over one year or inaction on the part of OPEC+). At $50 WTI and normalized crack spreads Cenovus could easily be a $10 stock again versus their current trading price of $3.45 (if they escape being acquired by another operator beforehand/

PAST PICKS: APRIL 26, 2019

BAYTEX ENERGY (BTE TSX)

• Then: $2.74
• Now: $0.40
• Return: -85%
• Total return: -85%

CRESCENT POINT ENERGY (CPG TSX)

Then: $5.37

Now: $1.35

Return: -75%/

Total return: -75%

MEG ENERGY (MEG TSX)

• Then: $6.05
• Now: $2.27
• Return: -62%
• Total return: -62%

Total return average: -74%