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

MARKET OUTLOOK

We are at the cusp of the next bull market for oil. Demand appears to have finally inflected positively after several months of very tepid growth (1.1 million barrels per day of growth in Q3) with hopes of a U.S.-China trade truce in the coming months. U.S. shale growth has sharply decelerated from a high of 1.9 million bbl/d year-over-year in August 2018 to 1 million year-over-year growth in August 2019 and its likely to only grow by 500,000 to 700,000  bbl/d in 2020. Meanwhile, global offshore oil production (27 per cent of global production) will peak in 2020, entering into a multi-year decline due to a lack of sufficient investment in four- to seven-year lead projects. Barring an end to Iranian sanctions by the U.S., the market should be undersupplied in the second half of 2020, resulting in strong inventory draws.

Energy stocks today trade near their lowest valuations in history. Discounting less than $50 barrels, many Canadian midcap stocks trade at about 15-per-cent free cash flow (FCF) yields at $55 WTI, over 20 per cent FCF yields at $60 and at three to four times their enterprise value to cash flow (EV/CF) at $55 to $60 WTI. We expect 2020 budgets to focus on maintaining flat production while maximizing FCF to allow for meaningful share buybacks. Given how under-owned the sector has become (index weights less than 50 per cent of historical levels) and how bad sentiment is (despite strong medium-term fundamentals), we believe that investors should be increasing their energy exposure now.

TOP PICKS

PAREX RESOURCES (PXT:CT)

Parex’s superior business model allows for modest growth combined with aggressive share buybacks and is proof that dedicating a meaningful amount of FCF towards share buybacks works. The stock is up 25 per cent year-to-date, significantly outperforming its peers. Having bought back 15 million shares to date, we look for the company to buy back another 10 per cent of their shares in 2020 while growing production by 5 per cent and generating excess FCF. Trading at 3.4-times EV/CF at $60 Brent and a FCF yield of 16 per cent, we believe the stock is undervalued.

TORC OIL & GAS (TOG:CT)

TORC is a mid-cap Canadian light oil producer that yields 8.3 per cent (sustainable to $48 WTI) and trades at a post-dividend FCF yield of 6 per cent at $55 WTI and 12 per cent at $60 WTI. Trading at 3.2-times EV/CF at $60 WTI and 101 per cent of its proved developed producing reserve value, we see upside in the stock as the company uses its FCF in 2020 to buyback over 5 per cent of its shares and help reduce the dislocation in its corporate value.

WHITECAP RESOURCES (WCP:CT)

Whitecap is a mid-cap Canadian oil producer that yields 8.3 per cent (sustainable down to $49 WTI) and trades at a post-dividend FCF yield of 6 per cent at $55 WTI and 13 per cent at $60 WTI. Trading at 3.7-times EV/CF at $60WTI and 85 per cent of its proved developed producing reserve value, we see upside in the stock as the company uses its FCF in 2020 to buyback over five per cent of its shares and help reduce the dislocation in its corporate value.

PAST PICKS: NOV. 16, 2018

BAYTEX ENERGY (BTE:CT)

• Then: $2.60
• Now: $1.62
• Return: -38%
• Total return: -38%

PARSLEY ENERGY (PE:UN)

• Then: $22.14
• Now: $15.94
• Return: -28%
• Total return: -28%

DIAMONDBACK ENERGY (FANG:UW)

• Then: $114.31
• Now: $76.29
• Return: -33%
• Total return: -33%

Total return average: -33%