Disclosure: The following represents my opinions only. I am long ATH.TO, ATU.V, BTE.TO, CJ.TO, CPG.TO, MEG.TO, TAO.TO, TGL.TO, WCP.TO, and YGR.TO (Image credit to Shaah Shahidh on Unsplash)
Wow, what a difference a couple of weeks can make. Any reservations that the oil market had with respect to the March 4th OPEC meeting were washed away with some of the most bullish OPEC posturing in a very long time. Knowing that a U.S. shale response will/should be a shadow of its former self, OPEC is intentionally tightening the physical market at a time when global oil demand continues to recover. And, as things stand, the market is powerless to do anything about it in the near term, as OPEC is the only one with any real spare capacity right now. Effectively, OPEC is deciding when to be the “relief valve” on oil prices, but my sense is that they are still aiming to sustain oil prices higher than $70 per barrel as they choose price over volume. Think about it… if you can sell 15% less product, but get a 25% higher price for the product you do sell, you’re ahead of the game. As it stands today, I think that OPEC can now afford to experiment over 3-6-9 month periods to test/monitor the U.S. shale response. With the oil industry mantra now shifting from “growth-at-any-cost” to “pay-down-debt-and-return-capital-to-shareholders”, it’s going to be interesting watching it play out. Will producers stay disciplined? Or will they return to their “spend like a drunken sailor” ways? Stay tuned. In the meantime, get used to a rolling backwardation structure in the physical oil market, imposed by OPEC’s current stance (backwardation acts as a deterrent for producers looking to hedge forward production, as future prices are lower than the near months).
If you haven’t noticed, energy stocks continue to be on a tear, digging out of holes so deep that you never thought they’d see daylight again. This is despite the fact that I continue to see a lot of skepticism when it comes to the energy trade as memories of the past seven years are slow to fade. The crazy thing is, that even after the big moves many of the energy stocks have had, they are still really, really cheap as a group. Anyone that wants to hear the bull case needs to watch this video from Ninepoint’s Eric Nuttall. Eric has been one of the only lighthouses in the dark for Canadian energy investors for a very long time and is being rewarded now for his years of staying on top of things. When a market turns, like oil just has, it’s so critical to be able to identify and target opportunities quickly… and that can only be done by staying in a constant state of readiness. Well, Nuttall was born ready for oil bull markets and he has been generous with his Twitter posts, providing comparative valuation charts (like these) that might help newcomers focus their due diligence efforts. I always keep my energy seat warm, but Nuttall takes it to a truly professional level; and at times like these, he’ll be a lightning rod for energy market interest and guidance. His assets under management already show this effect, having swelled from $26 million at the lows to over $300 million today as money looks to deploy in the sector. Perhaps the most important point that Eric makes in his video is that, despite their recent (excellent) performance, energy stocks are coming off of levels where they had no business being in the first place; and many are still nowhere near what might be considered “fair value” when weighed in the context of prior years. That’s a view that I share, and it’s really easy to see when you pull up 3-5-10 year charts on any energy stock or index.
In a nutshell, I think that the energy sector is in the nascent stages of “rediscovery” by a market that still broadly believes that somehow civilization’s relentless dependence on hydrocarbons is going to evaporate overnight. Fortunately, the free cash flow that energy companies are generating right now is undeniable, so that dependence is going to be brought back into stark focus by the balance sheets of these entities over the coming quarters and years. As the increased dividends, debt repayment, and share buybacks in the sector continue to pile up, it’s sure to turn more heads and get people asking tough questions about why they’re not participating, and why exactly it’s “politically correct” to shun oil. If someone can explain to me why mining and refining a colossal amount of lithium, cobalt, nickel, copper, rare earths, aluminum, and other exotic elements is more “ESG friendly” than responsibly producing the very oil that’s needed to power the Green Transition, then I’m open to hearing it, but so far I’ve heard nothing convincing. In the near term, there is literally no alternative to oil and gas. None. Not even close. Even just trying to eliminate coal fired power (I’m not even talking about gas) is an absolutely monumental task, never mind trying to do it while needing to generate more and more electricity to power the growing fleet of EVs in the future. I’m not saying it’s not going to happen, but it is going to take some time. And during that time, I think the market will come around to the unique value proposition that energy stocks are presenting and that my willingness to be “early” will be rewarded with analyst re-ratings across the board.
By no means am I expecting energy stocks to go straight up, but if they do, that’s fine by me. I have built a basket of names where I think I’m getting good value and leverage to a variety of outcomes. My oil net is pretty wide (this doesn’t include my gassy names), but for those who want to browse the stable, here goes:
Athabasca Oil (ATH.TO, last at $0.59)
Several months ago, one of our partners suggested looking at Sherritt (S.TO, last at $0.58) as a way to play the move in nickel. I turned up my nose because it was just a little too stinky in terms of the exposure I was looking for… After passing on that idea, I watched Sherritt march relentlessly higher, the whole time mocking my aversion to wanting to go that deep into the idea cupboard. ATH now reminds me of Sherritt on that day — ATH is so levered to the oil price that you’re scared to own it, but if oil goes to $80-90-100 it’ll knock your socks off with its free cash flow. Needless to say, I own some as a call option on oil, though it does have a gas kicker.
Altura Energy (ATU.V, last at $0.225)
I’ve owned this for a looooong time and haven’t made any money on it… yet. With its large, low cost, scaleable resource at Leduc-Woodbend (400 mmbbls OOIP), this is a classic microcap value story run by one of the best teams I’ve come across. Conservative and methodical, management has kept debt and abandonment liabilities low, as well as costs. This is pretty far down market (the market cap is only about $25 million and production is around 1,000 boepd), but represents an interesting penny speculation on oil and the management team. ATU sells its oil at a small differential to WCS (Western Canadian Select) crude pricing, which is enjoying the same price strength as the rest of the oil complex. There’s also a light oil play called Entice that ATU is evaluating, so you never know on that front.
Baytex Energy (BTE.TO, last at $1.48)
This is one of those plays that looked like it was going to drown in its own debt until recently, and all of a sudden BTE is being spoken of in the same breath as “impressive free cash flow” given its leverage to oil. The chart says it all. I remember thinking BTE was cheap at $4 not that many years ago.
Cardinal Energy (CJ.TO, last at $2.29)
I first put this back on the radar when Murray Edwards took on a piece of the company’s debt and around 18% of the equity. As they say, follow the money. CJ has great leverage to oil and screens very well on Mr. Nuttall’s twitter charts. Being a simple guy, I also like the fact that CJ still trades at a healthy discount to its end-of-the-world 2020 PDP NAV of $2.91/share. PDP NAV is typically the most conservative measure of an oil company’s fair value, so the fact that CJ still trades at a 20% discount to its COVID-19 price deck is impressive. CJ’s $1.4 billion in tax pools ($522 million of which are non-capital loss carry forwards) are nothing to sneeze at either. As I’m writing this, I’m thinking that CJ could be a target in the current M&A cycle.
Crescent Point Energy (CPG.TO, last at $5.70)
A sector bet, plain and simple. This one lives in the sweet spot of oil price torque. At these WTI prices, CPG prints money. I haven’t checked the multiples on it recently, but that alone should tell you something about my level of concern in terms of where I think the sector is when it comes to valuations. I want broad exposure as I get my bearings in terms of what to really focus in on, so I have a little.
MEG Energy (MEG.TO, last at $7.54)
In two words; tax pools. With some $7.4 billion in tax pools ($5.1 billion of which are non-capital loss carry forwards) and producers out there looking to shield their looming energy windfalls, MEG gets more interesting by the day. Not only would a corporate buyer get a world class asset with massive oil leverage by taking MEG out, but they would also get those tax pools… which would make for some big tax savings to someone who is currently, or soon to be, cash taxable. This is one of the few times that the word “tax” seems cool.
Tag Oil (TAO.TO, last at $0.30)
Perhaps the Littlest (Toronto-listed) Engine that Could? Abby is still playing a game of Where in the World is Carmen Sandiego with the market, but at some point he’s going to find a deal for TAO. The only thing that’s changed in my view of TAO is that the oil market has become wayyyyyy better than I thought it could in this time period. In hot markets, when companies get new deals, people tend to notice. This is one of my penny hopefuls where I am looking for outsized returns if I’m patient. Abby’s successful exits have all been in the multi-hundred millions of dollars, so I’m betting early on this one. TAO’s cash value is around 18c/share and the team here is as good as any when it comes to international oil hunting. TAO consistently references its access to capital, which is music to a penny stock holder’s ears. Tick tock goes the deal clock.
Transglobe Energy (TGL.TO, last at $2.06)
Transglobe reported some fairly meaningless 2020 numbers this morning. I don’t want to just brush off an annual report, but with TGL the report is reallllly backwards looking. This is because of the PSC renegotiation that the company concluded in December, which sets TGL on a totally new course. Ratification of the new PSC terms is expected in Q2 2021, at which point the deal will be retroactive to February 1, 2020. That’s going to create a big receivable on TGL’s balance sheet from EGPC that will then be offset against the $15mm bonus payment due to EGPC as part of the agreement. The net impact will most likely come out as a net positive working capital adjustment for TGL and I imagine that it will require the restatement of the 2020 financials to reflect the retroactive nature of the deal. Clear as mud? In any case, one relevant thing that TGL did report this morning was that 2021 exit production is expected to be in the range of 10,300-10,700 bopd day in Egypt, with Canada exiting at 3,100-3,300 boepd under the announced 2021 budget. At the current level of $69 Brent and $65 WTI (hard to believe I’m even typing that), TGL will have netbacks of something like US$22/bbl in Egypt along with perhaps US$30/boe netbacks on its Canadian production (remember that Canada has a gas component). Try running those numbers. The Egyptian cash flow comes in at around US$85-90 million and Canada comes in at US$30 million. That’s pushing a US$120 million cash flow run rate at current prices. At CDN$2.06, where TGL closed today, its market cap is CDN$150 million and it has positive working capital of about CDN$18 million, giving it an enterprise value of CDN$130-135 million. If you’re still following me, that’s an EV of CDN$130-135 million versus cash flow at exit rates and current prices of US$120 million (CDN$150 million). Not to toot my own horn, but I said that this is exactly what I hoped would happen four months ago. The oil price has moved higher and as a result TGL is still trading at less than 1x EV/CF on an exit 2021 run rate (usually analyst targets are based on 2022 numbers, which is why I’m focusing on exit rates). Yeah, sure Malcolm that’s great, but what’s the catalyst? Well, sometimes you don’t need one. If TGL is generating US$120 million a year in cash flow, and G&A is $12 million, EGPC bonus/renegotiation payments are $10 million per year, and capex is US$30 million per year (this year capex is US$27.2 million), that leaves some US$70 million of annual excess cash flow in play. Hmmmm… there’s a lot of margin for error here when it comes to getting to a very attractive free cash flow scenario backed by a stated corporate mission of reinstating share buybacks and dividends. Once the company gets the new PSC terms ratified, I would expect the company to do a mid-year reserves update that I think will be an eye-opener for the market, so maybe that’s something to “look forward to” if boring gobs of free cash flow isn’t enough. The TGL of today is not the same as the TGL of yesteryear and I think the market is starting to figure it out. With a little patience I still think there are dollars on the table here, but that’s for the market to decide.
Whitecap Resources (WCP.TO, last at $6.12)
Not a lot to say here other than I like it as oil exposure. Consistently regarded as one of the best teams in the business, and one of the few companies offering CO2 sequestration, Whitecap should be on the radar of every “ESG” investor who realizes the insanity of the hypocrisy associated with being okay with lithium/metals mining and not okay with the oil needed to extract and process those metals… at least here they can check the “CO2 sequestration” box. All that aside, this is a go-to name for actual oil investors who just like to have a piece of an established and well-run oil company that’s on a path of increasing dividends over time.
Yangarra Resources (YGR.TO, last at $1.34)
This is a bit of a dark horse. Left for dead in the 30-60 cent range in 2020 (those prices were just variations of “zero”), I’ve tracked YGR for years as I’ve always been a fan of CEO Jim Evaskevich, his high share ownership, and his ability to manage the operation like you’d think an owner would. Yangarra caught my eye last summer again as offering good value (massive discount to NAV at the time) and since then I’ve learned that the company has spent the last few years getting its house in very good order. Jim has been diligently working on creating a very low-cost, largely self-sufficient, operation while focussing on his highly economic bioturbated Cardium play. Like some other companies, the debt was looking a little daunting for a while there, but at these prices, YGR prints money and would plot at the lower end of Mr. Nuttall’s charts. I think this is a small cap to watch in this environment and I own a decent piece. YGR was once a market darling and it has never been a better looking operation, so maybe it can regain its premier status over the coming quarters and years. YGR’s 2020 (aka COVID-19 year) PDP NAV is $1.37/share, so the stock offers good value on that basis. When things get interesting is when you look at the 1P NAV of $9.40/share. YGR is printing money right now and I think that the market is slow to recognize how much torque it has to energy prices given its tight capital structure. With only 85 million shares out, the share price move from 60 cents to $1.34 doesn’t mean much in terms of market cap, and is a pittance relative to how much YGR’s cash flow and outlook has changed in recent months.
Well, that more or less covers my oil basket at the moment, so here’s hoping that my continued faith in “old school” energy and simple math is rewarded. It’ll also give me something to read in six months or a year to see what I was thinking today. My view on oil is decidedly bullish… even at $55-60 oil, I think these stocks look cheap, so I’m long with what what I feel are healthy margins of error. Based on empirical metrics, I don’t think the market isn’t even close to properly valuing these companies, but that’s usually the case when I buy something out of favour. Now it’s just about the waiting… and so far the charts are making it pretty easy.