Aug 2, 2016

Dennis da Silva's Top Picks: August 2, 2016

BNN Bloomberg

Dennis da Silva , BNN

Dennis da Silva, Managing Director and Senior Portfolio Manager, Middlefield Group

FOCUS: Canadian Resource Stocks

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MARKET OUTLOOK:

In the United States, the data points to slow, but positive, economic growth. For much of the year, job creation has been a bright spot, and retail sales have been trending higher, pointing to healthy momentum for consumer spending. Notwithstanding the positive momentum in the United States, the challenges to global economic growth are a major concern and the U.S. Federal Reserve seems inclined to leave rates unchanged until late 2016 at the earliest. We continue to be constructive on energy prices over the medium and long term. Long term fundamentals for crude oil have set the stage for a more balanced energy market into 2017 while natural gas offers more near term price appreciation potential. Industry participants will be slow to put incremental capital to work as balance sheets still need repairing and prices are not yet high enough to generate attractive rates of return. Gold continues to trade at the higher end of our target range (US$1,100 to US$1,300/oz) in response to the lack of global economic growth, the volatility in the U.S. dollar and the prospect of negative interest rates. The easy money has been made as gold stocks recovered from trough gold prices. The key will be to focus on companies that can continue to improve cost efficiencies and margins in an environment of relatively stable gold prices while delivering growth per share.

Top Picks:

Birchcliff Energy (BIR.TO), June 2016 purchase at $6.25

The Gordondale asset acquisition from Encana for $625 million is strategic game-changer on all levels. The stock’s move since the deal only brings it back in line with peer group. The $700M equity deal associated with the acquisition was very well subscribed. The transaction and equity raise resolved concerns about debt and public float now that it has one of the better balance sheets and Seymour Schulich is diluted from 30 per cent to 17 per cent. Gordondale adds a significant liquids portion to the company’s profile which will drive better netbacks adds to a huge drilling inventory, and increases infrastructure capacity. The company has become the 5th largest Montney producer.

Premier Gold Mines (PG.TO), November 2015 purchase at $2.90

This company can re-rate by over 50 per cent as it becomes a 150,000 once gold producer this quarter. The Mercedes mine acquisition from Yamana late last week fills a production gap between the South Arturo mine and Hardrock project. South Arturo in Nevada puts them into producer status this quarter with the operator Barrick building it on time and under budget. It is small with a short life of 2.5 years but nice free cash flow generator ($60 million per annum over 2.5 years) with underground exploration upside. Recent private equity investment from Orion provides access to $400 million in capital for acquisitions or development. A production profile with established reserves and mine life expansion potential at Mercedes and South Arturo from exploration. Other catalysts include an updated resource at McCoy Cove for a potential second Nevada mine and a complete feasibility study on TransCanada joint venture with Centerra by year end.

Freehold Royalties (FRU.TO) May 2016 purchase at $11.55

Lower risk energy play given royalty structure. Unjustifiable discount to PrairieSky of almost 50 per cent. Revenue is about 2/3rds liquids with the company's payout also at 2/3 (50 per cent dividend). The balance sheet is top tier and the management team has always had more conservative guidance. Look for valuation gap to close given strong netbacks, b/s and low payout. Lastly, the recent sale of Penn West’s Viking assets to private company Teine has put a material component of CF (10-15 per cent) in strong spending hands that can accelerate spending. Quality of asset base reflected in flat production profile through the trough in oil/gas prices.