Sep 18, 2020

Eric Nuttall's Top Picks: Sep 18, 2020

BNN Bloomberg

Full episode: Market Call for Friday, September 18, 2020

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

MARKET OUTLOOK

Oil has seemingly found a near-term floor around $40 per barrel, while demand normalization continues and the inventory surplus begins to more rapidly draw down. While consensus varies wildly on the pace of eventual inventory/demand normalization, we see encouraging trends as traffic congestion in major cities around the world has reached pre-COVID levels, people switch from mass transit to driving and certain areas within aviation, like Chinese domestic flying, are only down 10 per cent. We expect demand to reach 100 million barrels per day again by late 2021, and with U.S. shale declines continuing, global offshore production stagnating/falling and OPEC sitting on limited spare capacity (adjusted for currently curtailed volumes), the outlook for oil over the medium- and long-term remains very strong. We think we will see $50 WTI in early 2021 and $60 WTI in the second half of 2021. With that backdrop, energy stocks remain extremely inexpensive trading at 15 to 40 per cent free cash flow yields at $50 WTI and 20 to 100 per cent free cash flow yields at $60 WTI. We see the best opportunities within Canada due to increasing takeaway capacity, lower financial leverage, foreign exchange benefits, and a greater ability to generate free cash flow due to lower corporate decline rates.

TOP PICKS

Eric Nuttall's Top Picks

Eric Nuttall shares his top picks: TORC Oil & Gas, Whitecap Resources and Freehold Royalties.

TORC Oil & Gas (TOG TSX)

TORC is a Canadian small-cap oil producer that is being completely ignored by the markets as most investors flock to the perceived safety of the large caps. Led by a management team known for conservatism and with the backing of the CPP (30 per cent owner), Torc is well positioned to take advantage of the coming M&A cycle driven by banks forcing consolidation and private backers wanting liquidity. Trading at 2.9/2.2 times enterprise value to cash flow (EV/CF) at $50/$60 WTI and at a 36/62 per cent free cash flow yield, TORC offers significant torque to a more bullish oil price outlook with a targeted upside of 153/283 per cent at a five times multiple of cashflow at $50/$60 WTI.

Whitecap Resources (WCP TSX)

Whitecap is a Canadian small-cap oil producer that pays a 6.4 per cent yield, has a relatively strong balance sheet (1.9 times debt to cash flow at $50WTI) and recently completed a highly accretive acquisition of a junior oil private producer (NAL). Trading at 4.1/2.9 times EV/CF at $50/$60 WTI and at a 20/38 per cent pre-dividend free cash flow yield at $50/$60, Whitecap has differentiated itself by being active in M&A as well as 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 six times EV/CF multiple we see 88/198 per cent upside at $50/$60 oil.

Freehold Royalties (FRU TSX)

Freehold is a royalty company that currently pays a 4.6 per cent yield (dividend was cut by 71 per cent in Q2; this was far too aggressive and hurt the stock) and offers lower-risk price leverage to improving oil and natural gas prices. With such an inefficient stock market given the reduced number of participants, Freehold’s stock has fallen as much as many conventional exploration and production companies (46 per cent year-to-date) despite a much stronger relative balance sheet (1.1 times D/CF at $50) and no exploration risk. Trading at a 17/21 per cent pre-dividend free cash flow yield and with a dividend that is well below their targeted payout ratio (60 to 80 per cent,) we believe Freehold can and should meaningfully increase their dividend while retaining some free cash flow for further acquisitions. With a recent CEO change, we are hopeful that the company can find an individual who can tell a livelier and more compelling version of the Freehold story resulting in the stock trading closer to its royalty corp. peers (currently 6.3 times at $50 WTI).