Jul 20, 2018

Eric Nuttall's Top Picks: July 20, 2018

BNN Bloomberg

Eric Nuttall , BNN Bloomberg

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

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MARKET OUTLOOK

Oil is in a multi-year bull market and we believe will trade to $100 per barrel in late 2019. The view is based on our forecast for oil inventories hitting their lowest level in history around December 2019 and OPEC spare capacity becoming exhausted next year. Due to the drop in spending on long-lead projects by 90 per cent of global oil supply over the past four years (basically every country other than the U.S.) and four-to-six year cycle times, we believe that supply is unable to meaningfully grow over the next several years and that the price of oil will have to act as a “demand destructing mechanism” in order to prevent inventory levels from reaching critically low levels. Historically this has happened when oil represents more than 5 per cent of the global economy, which would imply and oil price of about $120 per barrel.

The road to $100 oil however will not be smooth as short-term timing issues between OPEC4+Russia’s production ramp of 1 million barrels per day versus pending Iranian exports reductions (about 1.6 million barrels per day), worries about trade wars and a Strategic Petroleum Reserve release ahead of November mid-term elections, and Libyan export resumptions has led to a short-term selloff, with oil trading at three-week lows. As we own stocks which we believe will more than double over the next year, we're willing to endure the short-term volatility by keeping the end in mind. The long-term trends of underinvestment, persistent demand growth and rising depletion rates are fully intact.

TOP PICKS

MEG ENERGY (MEG.TO)

MEG offers the highest oil price torque of any energy stock in Canada, with EBITDA increasing by 40 per cent with a $10-increase in WTI to $80 in 2019. This week, the stock has fallen by 16 per cent as a short-seller attack has pressured the stock. Very short-term concerns about pipeline access due to congestion (which will impact all heavy oil producers) will likely lead to a weak Q2 and possibly Q3. But these are very short-term issues, as crude-by-rail is set to more than double to 500,000 barrels per day of capacity by Q3/19 and Line 3 will see the WCS differential contract next year. We own MEG for its 50-plus year reserve life, free cash flow profile (15 per cent free cash flow yield currently), normalizing debt levels (2.2 times in 2019), and unmatched operational leverage to an increasing oil price. At $80 per barrel, we believe MEG could trade to $18.70, representing a 6 time EBITDA multiple, which offers over 110 per cent upside.

BAYTEX ENERGY (BTE.TO)

The Baytex and Raging River merger is set to close in August and with it, the elimination of a major overhang (hate-selling by some Raging River shareholders). We view the “new” Baytex as a much improved version, with a refinanced balance sheet (1.6 times debt to EBITDA at $70 per barrel), increased free cash flow generation from Raging River's Viking asset (along with Baytex's Eagle Ford asset), and new exploration upside in the East Duvernay Shale Play (along with Baytex's Northern Seal play, whose first well was exceptional with a three-month payback). We see the confusion around the proforma entity leading to a very undervalued stock. At $70-to-$80 oil in 2018 using a 5-times multiple, we see fair value at $6.90 to $10, offering 60 per cent to 135 per cent upside once the fog lifts.

ATHABASCA OIL (ATH.TO)

Athabasca Oil is likely to monetize some midstream assets in the next two months for which the Street is ascribing zero value, which will allow Athabasca to essentially become debt-free and offer the second-highest torque to an increasing oil price. At $70 per barrel, we have them trading at 2.8 times EV/EBITDA and at 2.1 times at $80/bbl. Given the attractive free cash flow of their oil sands at current pricing and the exploration upside of their Duvernay asset, we believe Athabasca could trade to 5 times, which would equate to 102 per cent to 172 per cent upside at $70 to $80 WTI.