Eric Nuttall's Top Picks
Eric Nuttall, partner and senior portfolio manager at Ninepoint Partners
Focus: Energy stocks
The market remains gripped with panic from the coronavirus outbreak, resulting in the price of oil falling by over 15 per cent due to worries about very short-term demand disruption. This issue is transient and it too shall pass.
The oil market stands on the cusp of a multi-year bull market driven by a number of factors:
- U.S. shale growth rates are sharply decelerating. We are looking for 700,000 barrels per day (bbl/d) of growth in 2020, down from a peak run rate of 1.8 million bbl/d. A recent survey of over 24 shale executives called for under 400,000 bbl/d of growth in 2021.
- Global offshore production (about one out of four barrels produced globally) is entering into a multi-year decline due to insufficient investment over the past five years.
- There’s insufficient OPEC spare capacity to meet the “call on OPEC” over the next five years. We believe that once the panic and hysteria fade, oil can rally back to $60 in the second half of 2020. The recent plunge in energy stocks (especially in the midcaps) will be seen as a gift.
The most attractive energy investment opportunities anywhere in the world are in Canada: Valuations are the lowest (some stocks trade at 2.5 times enterprise value to cash flow (EV/CF)with a 20 per cent free cash flow yields), sentiment remains terrible and yet the country is quickly building out incremental takeaway capacity and oil differentials are continuing to fall. Medium-term fundamentals (2022 to 2024) call for an oil price much higher than $60, yet at that level, we’re deploying fresh capital in names in which we believe can more than double in value. Never waste a good crisis.
TAMARACK VALLEY ENERGY (TVE TSX)
A new position in the fund, Tamarack offers highly compelling valuation as well as material leverage to a rising oil price. With a bulletproof balance sheet (1.1 times debt to cash flow with the oil price at $50) and massive free cash flow (21 per cent free cash flow yield with oil at $60), we think the ongoing waterflooding success and potential exploration success could lead to a modest re-rating of the stock. Given that it is trading at only 2.4 times EV/CF at $60 WTI (3.3 times at $50WTI), a small inflow of capital downcap could lead to a material rise (a trading multiple from 2.4 to four times equals 212 per cent upside). We also think that if M&A were to pick up, Tamarack’s strong balance sheet could offer an attractive way for a more over-levered midcap to fix their balance sheet issue (and perhaps maintain an unsustainably high dividend).
BAYTEX ENERGY (BTE TSX)
Baytex recently refinanced its debt due in 2021/2022 out to 2027, providing plenty of breathing room and alleviating any market concerns about the company’s exposure to a temporarily low oil price (despite a 50 per cent 2020 hedge position at C$76). Trading at 3.5 times EV/CF and a 28 per cent free cash flow yield, Baytex is prioritizing debt paydown this year ($200 million of free cash flow) while slowly delineating its East Shale Duvernay play. Baytex remains one of our favoured midcap ways to get exposure to our bullish call that oil will rally to $60 in the second half of 2020.
PRECISION DRILLING (PD TSX)
While we have strongly advocated for E&P (exploration and production) to prioritize share buybacks over growth, a certain level of activity is required to maintain flat production. With the stock down 42 per cent over the past year, the share price more than discounts the anemic level of activity that we see in 2020 (Helmerich & Payne is forecasting a 14 per cent drop in drilling activity). Precision is estimated to generate free cash flow of $220 million this year, which equates to a 47 per cent free cash flow yield (13 per cent on an enterprise value basis), enough to privatize the company in 2.5 years out of free cash flow (and they bought back 17 million shares in 2019).
PAST PICKS: MARCH 8, 2019
WPX ENERGY (WPX NYSE)
- Then: $11.41
- Now: $11.87
- Return: 4%
- Total return: 4%
DIAMONDBACK ENERGY (FANG NYSE)
- Then: $95.50
- Now: $74.16
- Return: -22%
- Total return: -22%
MEG ENERGY (MEG TSX)
- Then: $5.07
- Now: $6.74
- Return: 33%
- Total return: 33%
Total return average: 5%