Eric Nuttall, portfolio manager, Sprott Asset Management
FOCUS: Energy Stocks
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MARKET OUTLOOK

Despite horrible performance YTD the ingredients for a powerful rally in oil are in place: epically horrible sentiment (lowest energy ownership on record), extremely attractive valuations (stocks trading at half their normal valuations), very high short interest in many stocks (some Fund holdings have more than 30 per cent short interest), and an already strong and improving fundamental backdrop (OECD inventory overhang plunging, U.S. production growth stalling, global oil demand strongly increasing). The level of pessimism is offering many very attractive opportunities, especially in the service sector. We own companies trading at 10 per cent to 20 per cent free cash flow yields with partial contract visibility so in the extreme case one of holdings could theoretically buy back its entire outstanding debt and market cap within five years and has contract visibility for the next three years on the majority of its production. These are the kinds of opportunities fear provides an investor today.

TOP PICKS

PROPETRO (PUMP.N)
PUMP is a pure play pressure pumper in the Permian Basin which is the lowest cost source of meaningful supply in the world. They have a new fleet which is fully booked throughout the year and have been successful in pushing through price increases YTD.  They have long standing relationships with the best shale producers in the basin which in many cases have recently increased their 2018 hedge books (PE is 90 per cent hedged on 2018 oil volumes, PXD is 70 per cent hedged) thereby offering very good visibility on 2018 spending levels. PUMP is trading at 3.5 times 2018 EV/EBITDA vs. a normal multiple of 7-8 times. Once the market realizes that 2018 drilling activity will at worst be flat and that service intensity is continuing then PUMP should be able to get back closer to its normal multiple. The consensus price target is almost $19 = 58 per cent upside.

U.S. SILICA (SLCA.N)
US  Silica along with the other frac sand stocks have been decimated over fears about too much new capacity coming online in Texas which would be a relatively new area of frac sand production. What people are missing is that there is a mismatch with the type of sand to be produced from Texas versus what is actually being consumed there. We expect tightness in several of the main mesh sizes of frac sand which means EBITDA is much better insulated and therefore the fears of frac sand pricing in general collapsing are wrong. Demand is growing by 50 per cent this year and we think will grow another 20 per cent in 2019. SLCA trades at 4.7 times 2018 consensus vs. a normal multiple of 8 times but consensus has fallen by 20 per cent over the past few months which we do not agree with. We think SLCA is trading at 4 times 2018 with a 7 per cent FCF yield.

PARSLEY ENERGY (PE.N)
PE offers high quality exposure to the lowest cost oil shale basin in the world. PE is 90 per cent hedged on 2018 volumes at US$50/bbl and is set to grow production by over 50 per cent. The company has had very good initial success at unlocking a new zone in the Wolfcamp C which so far is proving to be extremely economic: IP30 production rates of 3,000+boe/d with oil cuts in excess of 60 per cent for US$6M = around US$5/bbl half-cycle supply costs. PE believes they have over 600 locations in this fairway offering visibility on over a decade of high return drilling. PE trades at 7 times consensus which is a slight discount to its Permian peers with a consensus target of $39 = over 50 per cent upside.

PAST PICKS: AUGUST 29, 2016

NYX GAMING ( NYX.V)

• Then: $1.90
• Now: $1.15
• Return: -39.47%
• Total return: -39.47%

AMERICAN HOTEL INCOME PROPERTIES (HOT_U.TO)

• Then: $10.77
• Now: $9.01
• Return: -16.34%
• Total return: -9.17%

BIRCHCLIFF ENERGY (BIR.TO)

• Then: $9.18
• Now: $6.10
• Return: -33.55%
• Total return: -32.76%

TOTAL AVERAGE RETURN: -27.13%