Oil services stocks will not profit from rising energy prices as quickly as oil and gas producers. Producers are able to work properties that are already in production. They don’t need to spend a lot of money drilling for oil.
Oil and gas stocks Cenovus Energy (TSX—CVE) and Encana (TSX—ECA) are expected to return to profitability in 2017. As a result, they are ‘buys’ again. Our Investment Planning Committee has upgraded them to a buy for long-term share price gains and modest dividends. But only if you can accept some risk. However, two other energy stocks, Ensign Energy Services (TSX—ESI) and Savanna Energy (TSX—SVY) remain ‘holds’.
Cenovus Energy is an integrated oil company in the business of developing, producing and marketing crude oil, NGLs (natural gas liquids) and natural gas in Canada with refining operations in the United States. In 2017, Cenovus Energy is now expected to earn six cents a share. This would represent a turnaround from the $1.01 a share it’s thought to have lost in 2016. The consensus recommendation of three analysts is that Cenovus Energy is a ‘buy’. We agree.
Similarly, in 2017, Encana, another energy producer and marketer of natural gas, oil and NGLs is now expected to earn 27 U.S. cents a share. That would mark a turnaround from the seven U.S. cents a share it’s thought to have lost last year. The consensus recommendation of eight analysts is that Encana is a ‘buy’. We agree.
Beware of these risks
At the same time, risks exist. One is that Cenovus Energy and Encana trade at very high price-to-earnings ratios of 37.5 times and 47.9 times, respectively. If anything goes seriously wrong, their ratios could shrink. This would inflict losses on shareholders. Then again, price-to-earnings ratios are less significant when it comes to cyclical energy stocks.
A second risk is oil prices. OPEC (the Organization of Petroleum-Exporting Countries) has agreed to reduce its output by 1.2 million barrels a day—or a modest one per cent. A number of non-OPEC producers, including Russia, agreed to trim their production by 558,000 barrels a day. However, OPEC has a history of ‘cheating’. With many non-OPEC countries involved, it may become even harder to make sure that all producers stick to their commitments.
To the extent that these producers are successful in raising the price of oil, American shale producers will seize the opportunity. They can quickly raise their production. Higher oil prices will also encourage production from countries outside the agreement, such as Canada and Norway.
Ensign and Savanna remain ‘holds’
Our Investment Planning Committee continues to rate Ensign Energy Services a ‘hold’.
In 2017, Ensign is expected to lose 59 cents a share. This is worse than last year’s loss of 23 cents a share—though it beats the loss of 84 cents a share in 2015. These ongoing losses put its dividend at risk. The consensus recommendation of two analysts is ‘hold’. We agree.
Many energy producers are working their properties that are already in production. This is preferable to spending a lot money drilling for oil. That is, oil services stocks such as Ensign will not profit from rising energy prices as quickly as producers Cenovus Energy and Encana Corp. As a result, Ensign remains a ‘hold’.
Calgary-based Savanna Energy Services’ shares have jumped by nearly a third in the past six months. This reflects the fact that a takeover offer is on the table, a “strategic process” is under way and energy prices are higher. The company is expected to lose more money this year and next. Savanna remains a hold if you need no dividends. It could accept a higher offer or give up some gains if the strategic process fails.
Calgary-based Total Energy Services (TSX—TOT) has offered 0.13 of its shares, worth $1.74, for each share of Savanna. This offer is set to expire at midnight, after March 24. Savanna advises its shareholders to reject Total’s offer. So do we, though we disagree with management on a couple of its dozen reasons for rejecting the offer.
The consensus of four analysts is that Savanna is a ‘buy’. That’s likely due to possible attractive alternatives. Our view is that the company is a ‘hold’ if you need no dividends. In 2016, it’s thought to have lost 49 cents a share. This is better than a loss of 86 cents a share last year.
In 2017, Savanna is expected to lose another 25 cents a share. If it continues to shrink, we’ll likely cut its quality rating by one notch, to ‘Higher Risk’.
Savanna could accept a higher offer or give up some gains if the strategic process fails. It remains a hold.
This is an edited version of an article that was originally published for subscribers in the January 2017/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
The MoneyLetter, MPL Communications Inc.
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