Canadian oil stocks seeing as being very undervalued
Inside the Market Blog
Friday, September 26, 2014, 13:43:54
Sprott’s Eric Nuttall: Canadian oil stocks now ‘very’ undervalued
Eric Nuttall
Eric Nuttall, a guest columnist for Inside the Market, is portfolio manager of the Sprott Energy Fund.
The Canadian energy sector has experienced one of the worst monthly corrections in recent memory, with many oil stocks down by more than 20 per cent. Perhaps a little perspective is in order.
I queried a handful of Canadian oil executives this past week after the stock market pummeling, asking "how's business." The universal reply was "great."
One might have expected a more dour answer.
But consider the following: Despite oil having sold off this month by about 3.5 per cent in U.S.-dollar terms, when you take into account the positive impact of the falling loonie and the marginal shrinking of the Canadian light differential, the price of oil is down less than 2 per cent.
Further, given the continued efficiency improvements in how wells in many oil plays are being drilled and fracture stimulated, oil well economics today are the highest they have been in decades. I routinely see wells paying out in under a year, which speaks to the impressive returns that these oil executives are seeing.
Finally, the oil executives pointed out that service-cost inflation - the rise in costs for such things as drilling rigs and labour - is essentially non-existent, and that drilling and pressure pumping equipment availability is not a problem. In short, business is indeed great and they foresee another strong year in 2015 of impressive production gains that will generate excellent investment returns.
Now, if I were to ask the average investor how they feel about the energy sector right now, I would expect their answer to be the exact opposite of the rosy responses of those in the business, given the daily shellacking of oil stocks and the negative feedback loop that it has created.
Herein lies the opportunity and an example of why it is important to see the difference between perception and reality.
The current perception is that the price of crude oil is down because the Chinese economy is weak and suddenly demand has declined, that a strong U.S. dollar means a lower oil price, and that oil stocks are overvalued. The exact opposite is true. China has been weak all year even when Brent oil was over $120 (U.S.) a barrel, global oil demand has strongly rebounded from the lows seen in the second quarter, and the correlation between the US. dollar/euro exchange rate and oil is virtually non-existent over more than a three-week period. I would argue that the energy sector sell-off is due solely to the broader market correction and nothing fundamental to the energy industry. In my view, Canadian oil stocks are now very undervalued.
Fools call market bottoms and buy into the group think of the day. Shrewd investors identify when the difference between perception and reality becomes too large to ignore while allowing for the possibility that such circumstances can persist for a time. Today I can buy many mid-cap light oil companies that are down 20 per cent month-to-date, and as a result, are now trading below 4 times 2015 enterprise value to cash flow. They are all growing production by at least 15 per cent to 20 per cent next year and have strong balance sheets that can withstand any short-term volatility. Some are even paying sustainable dividend yields of 5 per cent or more.
This opportunity rarely occurs. The risk-reward in the oil sector today is the best I have seen in several years. I myself recently purchased shares in Legacy Oil + Gas Inc. and Gear Energy Ltd. during the pullback for my own fund, among others.
See the reality of today and don’t buy into the market’s misplaced perception. From my experience, this can be a setup to highly profitable times as fundamentals eventually win out and stocks again reflect them.
AI
