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

MARKET OUTLOOK

For the first time in 10 months we can look with confidence towards a post-COVID world in the second half of 2021 and recognize that no sector has been harder hit than the energy sector given the temporary hit to demand. As the market looks through the next few months towards a normalized demand picture in 2021, focus will switch from the temporary impact on demand to the structural impact on supply. The fear of peak demand is leading us to the reality of peak supply. U.S. shale growth is largely over given the need for U.S. E&Ps to prioritize debt reduction, dividends and share buybacks over growth. Further, it is clear global integrateds in their desperate attempt to gain greater investor relevance are meaningfully increasing their investments in renewables while spending less on traditional hydrocarbons, so much so that Royal Dutch Shell said that 2019 will be their high watermark for oil production and BP is allowing hydrocarbon production to fall by 40 per cent over the next nine years.

2020 should also mark the peak of the renewable energy hype and allow for funds flow to return to the traditional energy sector: the world’s population is set to grow by 24 per cent by 2050 (predominantly in non-OECD countries whose oil demand growth will offset all of the decline in OECD countries) and yet by that time hydrogen will only have displaced 4 per cent of global oil demand from today’s levels and renewable diesel at most will have displaced 1 per cent (assuming that every single soybean in the world is used for diesel production versus agriculture). While electric car penetration rates will meaningfully increase due to government policy the actual number of internal combustion engine cars is set to grow for many years to come and EV growth rates will be curbed by a shortage of physical materials.

TOP PICKS

TORC Oil & Gas (TOG TSX)

A top pick for several shows now, TORC offers compelling valuation using strip pricing (which is unsustainably low) and very meaningful upside in a better oil price environment. At strip pricing of $43 WTI in 2021, TORC could generate free cash flow of $63 million equating to a 15 per cent free cash flow yield (they could privatize themselves in six years at the current oil price). We think oil could rally to $50 WTI in early 2021 and eventually $60 by year-end 2021 at which time TORC would be trading at a 29/50 per cent free cash flow yield. Given management’s reputation for delivering, adequate balance sheet strength and ability to weather the storm we see upside of 106/211 per cent using a 5 times multiple at $50/$60 WTI. Further, with CPP as a major shareholder we hope TORC is able to scale up in order to gain greater relevancy via M&A and as the commodity price improves, their ability to reintroduce a dividend should lead to a quick rerate.

Whitecap Resources (WCP TSX)

Whitecap is a Canadian small cap oil producer that pays a 5.1 per cent yield, has a relatively strong balance sheet (2.1 times debt to cash flow at $50 WTI) and recently completed a highly accretive acquisition of a junior oil private producer (NAL). Trading at 5/3.5 times enterprise value to cash flow at $50/$60 WTI and at a 15/30 per cent pre-dividend free cash flow yield, Whitecap has differentiated itself by being active in M&A as well as being the only net negative emissions producer in Canada given their CO2 reinjection project. With investor interest still largely concentrated in the large caps, Whitecap has the highest likelihood of a rerate when sentiment on oil improves. At a targeted 6 times EV/CF multiple, we see 34/121 per cent upside at $50/$60 oil.

MEG Energy (MEG TSX)

If you’re bullish on oil, the first oil stock to buy is MEG. Trading at the highest free cash flow yield of any oil stock in Canada, it offers unrivaled torque to an improving oil price in 2021. Further, with the oil strip at $43 WTI MEG is in a position to be able to keep production flat while satisfying all financial obligations given their higher than average debt levels offering optionality to better days ahead. We are bullish on both oil and on WCS differentials; MEG will be the oil beta stock to own when interest returns to the energy sector.

PAST PICKS: DECEMBER 19, 2019

Baytex Energy (BTE TSX)

• Then: $1.73
• Now: $0.63
• Return: -64%
• Total Return: -64%

Crescent Point Energy (CPG TSX)

• Then: $5.51
• Now: $2.16
• Return: -61%
• Total Return: -60%

Tourmaline Oil (TOU TSX)

• Then: $15.06
• Now: $17.71
• Return: 18%
• Total Return: 21%

Total Return Average: -34%