Jul 19, 2019

Eric Nuttall's Top Picks: July 19, 2019

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Full episode: Market Call for Friday, July 19, 2019

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

MARKET OUTLOOK

To even the most casual market observer, it should be blatantly obvious that the energy sector is broken. Oil stocks no longer seem to correlate with the daily move in oil and have greatly lagged the 22 per cent year-to-date rally in the oil price. All too frequently this year, oil equities have posted meagre rallies of 0.2 per cent (or even fallen) on days when oil has rallied by 3 to 4 per cent, only to get hammered the next day by 6 to 8 per cent when crude has sold off on some macro headline (the U.S.-China trade stalemate, the Iranian truce, and weak demand growth among others).

The agonizing combination of limited upside participation with extreme downside capture has been soul-crushing. Valuations today are at their lowest level in history despite most companies having strong balance sheets. Due to depressed levels, these companies could fund share buybacks of over 15 per cent out of free cash flow. This will be the curative for the highest level of investor apathy ever. The time for action is now.

TOP PICKS

Eric Nuttall's Top Picks

Eric Nuttall, partner and senior portfolio manager at Ninepoint Partners, shares his top picks: Baytex Energy, Crescent Point Energy and Enerplus.

BAYTEX ENERGY (BTE.TO)
10% fund weight.

Baytex has fallen off of the radar screens of most institutional investors and as a result its valuation has collapsed to just 3.3 times enterprise value to cash flow (EV/CF), 71 per cent EV to proved reserve value, and a free cash flow yield of 30 per cent (at $60WTI). Operationally, the company has beat expectations for over two years and has recently drilled their most successful East Shale Duvernay well to date, delineating a play whose value could exceed the current market cap.

With debt to cash flow dropping below two times by the end of the year, Baytex will be able to imminently put in place a very meaningful share buyback program of over 20 per cent of their shares outstanding. Given its depressed valuation despite high free cash flow-generating capabilities, the company could privatize itself in the next three years from free cash flow or another entity offering a 50-per-cent premium to today’s price could get $500 million of proved reserve value or $2.7 billion of proven and probable reserve value for free. This is insane.

CRESCENT POINT ENERGY (CPG.TO)
10.5% fund weight.

Crescent Point’s new management team gets the current reality of the energy investment landscape and is aggressively targeting asset sales (infrastructure and non-core production) in order to pay down debt (less than two times debt to cash flow) to allow for a meaningful share buyback program (in addition to 5.6 million shares year-to-date). With its extremely distressed valuation (70 per cent of its proved developed producing reserve value, essentially its liquidation value; 27 per cent free cash flow yield, 3.3 times EV/CF), if the company were to use 30 per cent of proceeds from any asset sales it could retire 8 per cent of its shares outstanding. Once debt to cash flow falls below two times, we believe the company will be extremely aggressive at dedicating every single dollar of free cash flow towards share buybacks.

ENERPLUS (ERF.TO)
9.2% fund weight.

Given Enerplus’ pristine balance sheet (0.6 times debt to cash flow), high-quality assets that generate strong free cash flow and depressed valuation (just dipped below 1 time its proved developed producing reserve value, basically its liquidation value), the company has been active in buying back its own shares. We believe the company should use its balance sheet (an exception to our general rule) to buy back a meaningful amount of shares (in addition to 6.3 million so far), given a $100 million incremental debt-financed buyback would only increase D/CF by 0.1 times yet allow it to buy back 5 per cent of its shares outstanding.