Based on securities analysts’ buy, sell, hold advice for over 1,000 Canadian companies, here are two oil and gas stocks that made the Investor’s Digest survey’s Top 10 ‘Time to Buy’ list.
Energy investors awoke on the morning of Sept. 14 to news of a major attack on Saudi Arabian oil infrastructure. In a single word, the event was unprecedented.
While it may be impossible to predict what will come next for the international oil sector, most experts would likely agree on two points: Crude prices will be more volatile; and the geopolitical ‘premium’ embedded in crude prices is likely to be higher for the near-term.
Among energy investors, the knee-jerk reaction will be to buy the low-margin, high-leveraged names.
Although Raymond James Financial analysts Jeremy McCrea and Gordon Steppan wouldn’t necessarily disagree, they argue that investors don’t need to take on the added risk in these types of names quite yet given current valuations today across the broader sector.
Whitecap Resources rated a ‘strong buy’
They go on to highlight a couple of reasons why oil and gas stock Whitecap Resources Inc. (TSX—WCP) should be a name that investors consider given the recent crude price improvement. They assign it a ‘strong buy’ recommendation and a $6.50 per-share target price.
As mentioned earlier, low-margin and high-leveraged names may see the most torque to underlying cash flow but may not necessarily be the best performing stocks. In periods where crude oil prices increased, under-leveraged names can perform on par or even better than over-leveraged names, the analysts claim.
Secondly, in an energy market where everything is “inexpensive”, they highlight a common valuation methodology, albeit with a twist.
Messrs. McCrea and Steppan explain: “As this relates to Whitecap, we can see the company has historically always traded mostly in line to the mid-cap space . . . the historical discount of enterprise value to debt-adjusted cash flow (EV/DACF) is rather ‘unprecedented’ at a multiple of four” the analysts state.
The mid-cap sector trading average has historically been about 7.8 times EV/DACF. At four times, valuations are the least expensive they have been in the past 10 years when adjusting for commodity price expectations, even with recent turmoil in the Middle East. Assuming WCP trades up to five times EV/DACF, this would imply a $6.25 share price (or a 40 per cent lift).
Of the seven analysts who cover Whitecap Resources, all rate it a ‘buy’. This puts it in a three-way tie with Birchcliff Energy Ltd. and Tourmaline Oil Corp. for first place on our top-10 ‘Time to Buy’ list.
Torquing value without taking on undue risk
Meanwhile, there is better shareholder torque to be had thanks to asset and land acquisitions at oil and gas stock Tamarack Valley Energy Ltd. (TSX—TVE). Laurentian Bank Securities analyst Todd Kepler says an under-leveraged balance sheet can further support share buybacks.
The company has bought back about 1.2 million shares in the first half of 2019, in addition to almost 2 million shares last year. It expects to continue executing its current share buyback program (of about 225 million total shares outstanding) given the stock’s low valuation.
Besides the share buyback, Tamarack Valley completed a small (about $10 million) tuck-in acquisition at the Veteran waterflood (a secondary oil-recovery technique) earlier this year. Accretive acquisitions and asset optimization such as the Veteran waterflood can add more torque to shareholder value in more normal market conditions, says Mr. Kepler.
By the end of this year Tamarack Valley will have invested almost $60 million into the Veteran program, and will have drilled or converted 27 wells to water injectors.
“Unrisked” value of waterflood is over $8 a share
Over time, this program is projected to unlock an additional 100 million barrels of light oil or 10 per cent of the 1 billion barrels originally in place.
According to Mr. Kepler’s calculations, the “unrisked” value of the waterflood is over $8 per share, or over $4 per share using a 50 per cent risk factor. Tamarack Valley’s current corporate decline rate is about 38 per cent, and will decrease to 25 per cent by the end of 2020 with continuation of the waterflood program.
Tamarack Valley further projects that the decline rate improvement can add about 2,400 barrels per day of incremental oil production by year-end 2020.
Mr. Kepler calls for fourth-quarter 2020 production of 27,900 barrels of oil equivalent per day, which incorporates some contribution from this waterflood program.
Assigning a $5.25 per-share target price, the analyst maintains a ‘buy’ recommendation for Tamarack Valley Energy.
This puts it in a four-way tie for fifth place on our top-10 ‘Time to Buy’ list alongside Organigram Holdings Inc., Canadian Natural Resources Ltd. and Yangarra Resources Ltd.
This is an edited version of an article that was originally published for subscribers in the October 18, 2019, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.
Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846