Brexit casts a pall over oil and gas stocks

The UK vote to leave the European Union could contribute to a near-term setback in the energy sector. The Money Reporter recommends that any new investments in this sector be directed to the three oil and gas royalty trusts it recommends in its survey of ‘Best Income Trusts For You’.

The United Kingdom’s vote to leave the European Union, otherwise known as ‘Brexit’, has helped put a stop to the strong rally in energy stocks so far this year. These stocks, which have outperformed the S&P/TSX Composite Index since the beginning of the year, have lagged the market in July.

In light of Brexit, we think it only prudent to adopt a more cautious stance toward energy stocks. The vote, after all, raises concerns about the potential for a global economic slowdown, which would be bad for oil and gas prices. It has also caused the U.S. dollar to strengthen, and may cause it to rise further. Most commodity prices react negatively to U.S.-dollar strength. Then too, many energy equities are quite volatile, and the sector has made great gains this year. It would not be a surprise, therefore, to see a pullback in the sector over the near term.

We would be more inclined, then, to buy the shares of the three oil and gas royalty trusts we recommend in our Income Trust Guide on price weakness. And if you want to err on the side of conservatism, we continue to regard Arc Resources Ltd. (TSX─ARX) as the most defensive investment of the three.

Arc is one of Canada’s leading conventional oil and gas stocks. Its operations are focused in five core areas of western Canada: Northeast B.C., Northern Alberta, the Pembina field in Alberta’s Drayton Valley, South Central Alberta, and Southeast Saskatchewan.

The company delivered better-than-expected financial results in its first quarter. Cash flow per share was $0.04 ahead of the Street’s consensus estimate. For the three months ended March 31, 2016, Arc’s cash flow was $150.1 million, or $0.43 a share, compared with $191.5 million, or $0.57 a share, in the same period of 2015. The decrease reflected lower realized crude oil and natural gas prices.

But the company achieved record production during the quarter of 124,224 barrels of oil equivalent per day. Production was up four per cent from the final quarter of 2015, and three per cent from the first quarter of 2015.

Arc has one of the strongest balance sheets among its peers. The company’s long-term debt is just 1.6 times its annualized cash flow, well within our comfort zone of no more than two times.

The shares offer further recovery potential over time, assuming a recovery in commodity prices.

The stock trades at a somewhat high 12.0 times the $1.85 in cash flow per share it will probably earn in 2016. This multiple, however, reflects low commodity prices, and is worth it considering Arc’s high quality. The annual dividend of $0.60 a share, meanwhile, yields 2.7 per cent. Arc Resources is a buy for growth and income.


Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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