Eric Nuttall, partner and senior portfolio manager at Ninepoint Partners
FOCUS: Energy stocks
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MARKET OUTLOOK

Despite oil remaining at a two-year high, the interest level in energy stocks remains subdued. While frustrating in the short-term we believe this is creating an epic buying opportunity given the dislocation between the commodity price/fundamentals and the valuation of energy stocks. Oil will remain in a bull market for the next several years as inventory levels reach normalized levels by Q2 of this year and demand growth absorbs the return of OPEC shut-in production later in 2018. Oil rallied by seven per cent in 2017 and is up a further two per cent this year, yet many stocks are -30 per cent to -50 per cent over the same time frame. 

While some would prefer to chase the weed/bitcoin/blockchain manias which may end in tears (LEAF’s market cap = PD’s market cap and PD is generating $350MM of EBITDA this year, whereas LEAF is expected to generate a third of that in 2021), we can buy companies that are being forgotten whom have exceptional underlying fundamentals (multi-year high profitability, 100 per cent utilization with strong forward looking guidance, strong balance sheets) that are trading at half of their historical multiples and buying back their own shares.

We believe U.S. and Canadian energy service stocks represent the most compelling upside for when funds flow returns to the sector and are heavily exposed to pressure pumping companies.

TOP PICKS

TRICAN WELL SERVICE (TCW.TO) 
TCW has sold off recently on concerns about Canadian producer capex cuts given the implosion of Canadian natural gas pricing (AEC 2018 strip = $1.25/mcf) and the widening of oil differentials. Despite a likely five per cent YOY reduction in overall conventional spending, we believe the continued increase in pumping intensity (more pumping horsepower on a per well basis) will more than offset the spending cuts and therefore keep the Canadian pressure pumping market in undersupply for 2018. TCW trades at 3.7X 2018 consensus EBITDA versus a normalized mid-cycle multiple of 6X-7X.  At 6X 2018 TCW would = $6.25/share = 50% upside. Last purchased on December 14th at $3.70.

STEP ENERGY SERVICES (STEP.TO) 
STEP is a relatively new public company that offers exposure to the Canadian pressure pumping market and U.S. coiled tubing market. Given ARC Financial’s control block of 67 per cent, the stock trades at material discount to its peers at 3.0X 2018 and 2.1X 2019 EBITDA despite new equipment, a well-respected management team, net cash on the balance sheet, and exposure to the U.S. coiled tubing market where pricing is increasing even faster than pressure pumping. We believe STEP would be an excellent takeout candidate for Precision Drilling, where PD could pay a 50 per cent premium to the current share price and still have the deal be wildly accretive (pay 4.9X vs. 7.4X current multiple), while also being able to delever their balance sheet (D/EBITDA of 4.1X would fall to 2.5X)  and replicate PTEN’s successful land drilling/pressure pumping model, which would be much more attractive to investors than what is currently a pure play on North American land drilling. Last purchased on January 5th at $11.26.

SOURCE ENERGY SERVICES (SHLE.TO) 
SHLE controls about 60 per cent of the Canadian frac sand market and offers exceptional leverage to the trend of increased proppant loading in Canada (ie. using more sand on a per well basis to achieve higher productivity levels). Recent estimates from First Energy have the Canadian market for proppant reaching 7.8MM tonnes in 2018 (up from 6.1MM tonnes in 2017) and 10.2MM tonnes in 2019. We believe pricing will continue to increase in 2018 and escalate further in 2019. SHLE trades at 4.0X our 2018 estimate and ~3.4X our 2019 estimate (eight per cent 2018 FCF yield). Given their ability to further consolidate the Canadian market, we believe the market is greatly underappreciating their forward earnings power. If SHLE could get a closer multiple to their U.S. peers (SHLE has superior fundamentals to them), the stock today would be close to $13.00 = 45 per cent upside. Last purchased on November 6th at $8.99.

PAST PICKS: JANUARY 31, 2017

SPARTAN ENERGY (SPE.TO)

• Then: $8.55
• Now: $7.00
• Return: -18.12%
• Total return: -18.12%

BIRCHCLIFF ENERGY (BIR.TO)

• Then: $8.02
• Now: $3.94
• Return: -50.81%
• Total return: -49.92%

TRICAN WELL SERVICE (TCW.TO)

• Then: $4.89
• Now: $4.09
• Return: -16.35%
• Total return: -16.35%

TOTAL RETURN AVERAGE: -28.13%