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

MARKET OUTLOOK

The energy sector has been crushed this year as the market struggles to quantify the economic impact and degree of oil demand destruction resulting from the coronavirus. Unquestionably, oil demand in the first and now second quarter will be atrocious (the warmest winter on record didn’t help either). However, how can this be viewed as anything but a short-term event as global oil supply faces several structural (and very bullish) trends that will last for many years? U.S. shale growth is massively decelerating and can no longer be relied upon to satisfy normalized global demand growth (the first time since the rise of U.S. shale growth in 2015). Global offshore production (one in four barrels produced) is entering into a multi-year plateau/decline due to a lack of sufficient investment. OPEC sits on less than 2 million barrels per day (bbl/d) of real spare capacity and budget requirements (and the Saudi Aramco IPO) increase the pressure on them to withhold supply until much higher prices can be obtained. Geopolitical risks remain (though not impactful for now in an epically complacent oil market), with Libyan production down 1.1 million bbl/d this year. In spite of the short-term demand destruction oil is set (once the panic fades) to enter into a multi-year bull market in the second half of 2020 or 2021.

Oil was trading at $64 before the coronavirus outbreak due to lessening economic growth worries (the U.S.-China trade deal) and moderating production growth-tightening market. The panic that many are feeling is temporary. When people stop stockpiling toilet paper and return to their daily lives, oil demand will normalize and the underlying strong backdrop for oil will once again become clear. I still believe that oil can trade at $60 by the end of 2020 (and higher in the years ahead). With that as a backdrop, we are buying stocks at less than two times their enterprise value to cash flow (EV/CF) and at free cash flow yields in excess of 25 per cent. These valuation levels are historic. Sentiment is truly deplorable at the moment, but this too shall pass (though not without some more short-term nausea).

TOP PICKS

CRESCENT POINT ENERGY (CPG TSX)

Crescent Point is 50 per cent hedged in 2020 with a fully-funded program down to $46 WTI, thereby helping to immunize the business (but not the stock apparently, down 46 per cent year-to-date) from the short-term pricing weakness as a result of the coronavirus. Given that we believe in $60bWTI by the end of 2020 (and beyond), we have Crescent Point trading at 2.1 times EV/CF and at a 22 per cent free cash flow yield. On a reserves basis, using a $55 flat price the company only trades at 84 per cent of the blow-down value of the company. Pick your valuation metric, this stock has never traded cheaper.

MEG ENERGY (MEG TSX)

MEG is a midcap oil sands producer with 55 per cent of their production hedged in 2020 at a $59 WTI floor and at strip pricing ($48 WTI) it would still generate $225 million of free cash flow. With 33 years of proved production, the stock trades at 81 per cent of their blow-down value and with $60 WTI and a $17.50 WCS differential, at a 38 per cent free cash flow yield (14 per cent free cash flow yield on an enterprise value basis). With meaningful tax losses, increasing direct takeaway to the Gulf Coast via the Seaway and Flanagan pipelines in the second half of 2020, and an improving backdrop for Canadian WCS differentials in general, we think MEG could be acquired for over $9 per share in the coming years.

TAMARACK VALLEY (TVE TSX)

Tamarack Valley is a small cap oil producer that is partially protected from the current short-term oil price weakness with 32 per cent of their oil hedged at $57.33 and a very strong balance sheet (1.1 times debt to cash flow at $50 unhedged). On a reserves basis, the stock trades at 81 per cent of their blow-down value (proved developing producing reserves) and at a 30 per cent free cash flow yield at $60 WTI (my by-end-of-year oil price). On a cash flow basis the stock trades at 2.6 times EV/CF at $50WTI and 1.9 times EV/CF at $60. I’ve never in my career been able to buy a strong free cash flowing business at less than two times their EV/CF (at normalized oil pricing). This is historic.

PAST PICKS: APRIL 26, 2019

BAYTEX ENERGY (BTE TSX)

• Then: $2.74
• Now: $1.11
• Return: -59%
• Total return: -59%

CRESCENT POINT ENERGY (CPG TSX)

• Then: $5.37
• Now: $3.13
• Return: -42%
• Total return: -42%

MEG ENERGY (MEG TSX)

• Then: $6.05
• Now: $5.79
• Return: -4%
• Total return: -4%

Total return average: -35%

TWITTER: @ericnuttall
WEBSITE: www.ninepoint.com