Mar 26, 2021

Eric Nuttall's Top Picks: March 26, 2021

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Full episode: Market Call for Friday, March 26, 2021

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Eric Nuttall, partner and senior portfolio manager at Ninepoint Partners

FOCUS: Energy stocks

MARKET OUTLOOK:

Oil has entered into a multi-year structural bull market: demand is normalizing faster than most thought possible and looks to hit pre-COVID levels by end of 2021/early 2022, the era of U.S. shale hyper growth is overdue to both a required focus on investor return of capital and geological degradation, non-OPEC/U.S. (Canada, Brazil, North Sea, etc.) production is set to flat line for the next several years due to chronic underinvestment, and as OPEC+ brings on their 7.4MM Bbl/d of currently curtailed production throughout 2021 they will consequently be exhausting all of their spare capacity.

Inventories are set to reach normal levels by May/June providing a fundamental underpinning of ~$60WTI. As inventories continue to fall and the market tightness becomes more apparent we think oil will rally to $70+WTI in the second half of 2021. Our bias is for much higher prices in the coming years as fears of substitution are grossly exaggerated (substitutes like hydrogen are decades away) yet the fear of peak demand is leading to the reality of peak supply: if supply cannot respond to balance the market then demand must be killed by meaningfully higher oil prices.

Energy stocks remain severely mispriced. Using $60WTI we are currently buying stocks at 2.5X-3.0X EV/CF and free cash flow yields in excess of 20 per cent. The average energy stock we track could buy back all of their shares outstanding and pay back off of their debt in 6.9 years, making any concerns about the outlook for falling oil demand in 15-30 years moot. While energy stocks have been good performers year-to-date, we have only just begun. We see very meaningful price appreciation ahead for the energy sector and remain focused on Canadian energy stocks given low valuations, low decline rates, long reserve lives, and the best ability to offer meaningful return of capital (dividends, buybacks) to shareholders in the coming years.

TOP PICKS:

Eric Nuttall's Top Picks

Eric Nuttall, partner and senior portfolio manager at Ninepoint Partners discusses his Top Picks: Parex Resources, Tamarack Valley and Cardinal Energy.

Parex Resources (PXT TSX)

Parex is a profoundly mispriced Colombian oil producer. Parex trades at a meagre 2.4X EV/CF at $65 Brent and a 28 per cent free cash flow yield. With a net cash position of ~$460MM (17 per cent of their market cap) their biggest problem is to figure out what to do with all of their free cash flow. Given valuation investors are getting free optionality on further exploration success, a positive surprise on a new asset/core area entry, or potentially their being acquired by a more indebted company seeking to deleverage given Parex’s pristine balance sheet. We think fair value is 5X 2022 cashflow which at $65 Brent (roughly $60WTI) = $36.00/share = 72 per cent potential upside.

Tamarack Valley (TVE TSX)

Tamarack recently entered into the Clearwater play, the most profitable oil play in North America via a series of acquisitions offering a more exciting element to the story. Trading at only 2.5X 2022 EV/CF at $60WTI and a 24 per cent free cash flow yield we think Tamarack could soon begin to pay a dividend while also modestly growing production and further returning capital to shareholders via a share buyback. At $60WTI Tamarack could buy back all of its outstanding shares and pay off all of its bank debt in only 4.6 years yet has many more years than that of running room in their various plays. We think fair value is 4X EV/CF at $60WTI = $3.50 share price = 67 per cent potential upside.

Cardinal Energy (CJ TSX)

In the past month we have been able to buy ~8 per cent of the outstanding shares and like Cardinal for its very strong leverage to a rising oil price. With a $10 change in oil its free cash flow increases doubles. While sporting a modest market capitalization of $280MM and therefore likely restricting the number of possible institutional investors we find its current valuation of only 2.2X 2022 EV/CF at $60WTI to be unwarranted given its free cashflow yield (41 per cent at $60WTI). Given our bullish views on oil we think Cardinal could trade at 4x EV/CF which would equate to a $4.88 share price offering potential upside of 114 per cent.