The upside of down
Why the falling loonie is good news for Canadian oil producers. Also, three picks (and two new names) from Eric Nuttall
When he was younger, Max Fawcett wanted to make a mint in the markets. Now as the managing editor of Alberta Venture he gets to write about them. Close enough, right? He can be reached at email@example.com
by Max Fawcett
For the first time in a long time, Canadian oil is trading at a premium to U.S. oil. And the culprit? The falling loonie. Canaccord Genuity put out a note yesterday that the Financial Post’s Jonathan Ratner shared suggesting that investors play that by getting into three of the largest companies in the sector, Canadian Natural Resources (TSE:CNQ), MEG Energy (TSE:MEG) and Suncor Energy (TSE:SU) “For the first time since the Asian crisis in 1998 (when WTI plunged to $10/barrel) and the 2008-2009 financial crisis, Canadian E&Ps are trading at a roughly 20 per cent price-to-book value discount to US E&Ps,” Canaccord’s Martin Roberge said in the note. And in both cases, the depreciated loonie eventually goosed profits – and stock valuation – for Canadian producers.
In his latest appearance on BNN’s Market Call tonight, Sprott Asset Management’s Eric Nuttall picked up on that trend, noting that the effect of the falling loonie is an eight per cent bump in the price Canadian producers are getting for their product. That’s not the only good news he brought with him, either – he thinks the ongoing political instability in the Middle East and the tight global supply of oil will be supportive of prices. And while Iran’s production may come back on line as international sanctions ease, its reservoirs will need considerable work – and investment. Meanwhile, something is brewing elsewhere in the region. “Potentially, we’re looking at something [like the Arab Spring] in Saudi Arabia,” Nuttall said.
In terms of his picks, he tapped perennial favourite TORC Oil and Gas (TSE:TOG) as one of his three top picks. Why? He thinks it was one of the most defensible business models in the patch. “When you look at their budget, they’ve assumed zero chance of success in their exploration,” he said, noting that they’ve drilled two wells recently in areas where other companies have enjoyed some tremendous results. “If either of those two wells are successful, and I’m guessing they will be, that will lead to a 10 per cent increase in their production guidance.” He also likes management, and notes that they own more than $50 million in company stock. “I feel safe giving them my money,” he said. TORC is the second largest holding in his fund, and he thinks it can get to $12 (a roughly 20 per cent upside) in the medium term while continuing to pay its dividend.
His second pick, Alexander Energy (TSXV: ALX), won’t be nearly as familiar. The former management team at Spartan Oil and Spartan Exploration came in and did a recapitalization in December, and he thinks the long-term upside associated with them and their reputation is worth paying for. “It’s a team that I really want to back. This isn’t a one month call or a one quarter call. This is a team that you leave money with for a year or two years. What it is today is not what it will be in two years, and this is the perfect environment for it, because there are so many assets on the market today. They can use that currency [from their private placement] and back fill their valuation.” He expects a name change in the near term – probably to Spartan Oil and Gas. Clearly, the street doesn’t reward creativity.
Finally, he liked Cardinal Energy (TSE:CJ), a private company that just went public a few weeks ago. Part of the appeal is the fact that it’s a new name and a new story (the absence of publicly available research on it means that those who understand the company, as he does, have an edge) but he’s also attracted to the stability and sustainability of its business model. “They have one of the most sustainable dividend models – more, by the numbers, than TORC. They’re using 83 per cent of their cash flow to grow their production by nine per cent and pay a 5.5 per cent dividend.” The company has some free cash flow on top of that, which gives it some margin for error and may allow it to increase its cap-ex spending or hike the dividend later in 2014.