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

MARKET OUTLOOK

We stand at the cusp of a new bull market for oil, painfully deferred thrice by a White House-induced Saudi production surge in 2018, a US/China trade war in 2019, and in 2020 by a global pandemic causing the largest (temporary) demand shock in history. The silver lining for oil bulls is that the events forcing an agonizing walk through investment purgatory also cemented the realities that will cause oil prices to surge in the coming years. This includes an exhaustion of Tier 1 US shale inventory and continued disenfranchisement of energy equities. Ongoing fiscal discipline and a complete re-evaluation of the US shale business model going forward and continued under-investment in long-lead mega projects will result in stagnating global offshore production and eventual decline. We will also see increased fiscal urgency among OPEC nations, fostering a high degree of cooperation and compliance. Within the next two years it seems likely that given US shale output inelasticity to a rising oil price and global demand growth that OPEC’s capacity will be exhausted. This will lead to a price spike, incentivizing new investment in long-lead projects and temporarily rationalizing demand so as to balance the market. Given that the average lead time of such projects is 4 - 6 years the longevity of the next oil bull market should allow for significant upside in energy stocks

We see the best opportunity in the world in Canadian small and mid-cap energy stocks trading at 20+ / 40+ per cent free cash flow yields at $50 / $60WTI in 2021 offering multi-bagger potential.

TOP PICKS
 

Freehold Royalties (FRU TSX)

Freehold has sold off as much as most regular E&P’s (-48 per cent YTD) despite having a much lower-risk business model (96 per cent of production is from royalties and D/CF of only 1 times at $50WTI). Trading at a free cash flow yield of 21 / 26  per cent (pre dividend) at $50 / $60 , Freehold is positioned to meaningfully increase its dividend in the near future. With a targeted payout ratio of 60 - 80 per cent and only a 21 / 17  per cent payout ratio at $50 / $60  we look for the dividend to be doubled or tripled while retaining excess FCF to purchase additional royalty interests and reverse its modestly declining production profile. A target 9 times multiple = $7 - $9/share (85 - 129 per cent upside) at $50 / $60  translating to a reasonable targeted 11 per cent free cash flow yield. Given its own distressed valuation we do not rule out shareholder activism in the name.

Whitecap Resources (WCP TSX)

Whitecap is a low-decline (18 per cent) low financially leveraged (2.4 times D/CF at $50) Canadian midcap oil producer. It is well positioned to be a consolidator in the next several quarters, as sector apathy is creating a target-rich environment for Whitecap to gain scale/investor relevance as well as further increase inventory depth. Trading at a modest 4.7 times / 3.3 times EV/CF at $50 / $60  WTI and a free cash flow yield of 25 / 45 per cent a more reasonable target multiple of 6 times = 60 - 177 per cent upside.

Torc Oil & Gas (TOG TSX)

Torc is a well-run small cap oil producer with a focus on conventional SE Saskatchewan oil and the Alberta Cardium play. With the backing of CPP (~30 per cent ownership) Torc is a likely consolidator in the quarters to come. Trading at 3.6 times / 2.6 times at $50 / $60WTI and a free cash flow yield of 22 / 45 per cent we see meaningful upside in the name over the coming year as a 5 times multiple = 74 / 188 per cent upside in a $50 / $60 WTI oil price environment.