Full episode: Market Call for Tuesday, April 17, 2018
Eric Nuttall, partner and senior portfolio manager, Ninepoint Partners
Focus: Energy stocks
Oil is in a multi-year-long bull market and WTI is likely to trade over $70 a barrel in 2019 and over $80 in 2020. The “oil glut” has disappeared, with OECD oil inventories falling by the fastest pace in history (334 million barrel surplus in January 2017 to a 20 million barrel deficit in March 2018), indicating an undersupplied market. With oil demand growth of about 1.8 million barrels per day this year and OPEC’s continued strong compliance to its production cut, we see inventories continuing to fall and reaching a 10-year low by year-end.
Looking to 2019 and beyond, even with the full amount of OPEC shut-in production returning to the market, we see inventories continuing to fall in the coming years with spending, labour, equipment and pipeline constraints on U.S. production and non-U.S., non-OPEC production about to enter into a multi-year decline. Eventually the oil price will have to rise high enough to rationalize demand in order to find balance, as the four to six-year lead time on large-scale mega projects prevents the industry from reacting quickly enough to any price spike or supply interruption. While the U.S. is good, it isn't good enough to meet global demand growth and offset the impact of non-U.S., non-OPEC production declines, with OPEC having limited ability to grow for the next several years due to underinvestment.
While sentiment remains close to all-time historic lows, there are signs of optimism emerging. The energy market has begun to outperform the broader market even on days when oil is down. Strategists are upgrading the sector and corporate M&A has begun. We see the potential to make over 100 per cent on many situations. The risk versus reward in the energy sector has never been better in my 15-year career.
|GLOBAL OIL SUPPLY||2018||2019||2020|
|Add: Demand growth||1.8||1.6||1.4|
|Total amount of required supply growth to reach balance||2.5||2.7||1.8|
|U.S. supply growth||1.2||1.2||1.2|
|OPEC+Russia supply growth||0||1.2||0.4|
|Non-OPEC, non-U.S. supply growth||0.2||-0.1||-0.4|
|Total estimated supply growth||1.4||2.3||1.3|
Units: millions of barrel per day; Source: Ninepoint Partners.
ATHABASCA OIL (ATH.TO)
Athabasca offers the highest leverage to a bullish oil outlook (or even where oil is at today) with a $5-move in WTI equal to 10 per cent of their current market capitalization. While excess leverage has been a problem in the past, we see the potential for them to monetize part or all of their infrastructure and be debt-free within the next four to six months.
Offering a 15 per cent production growth compound annual growth rate (CAGR) over the next several years, the company is growing fast enough to attract U.S. investors. They're doing this while also having the potential to initiate a share buyback, given that the stock is trading at only a 15 per cent premium to its blowdown valuation and less than half of its proved reserve value. We see Athabasca becoming the go-to oil beta name when sentiment firmly turns. We see the potential for a double from current levels (which would only get them to proved reserve value).
FTS INTERNATIONAL (FTSI.N)
FTS is a pure-play U.S. pressure pumper that recently IPO’d at $18 in February. Few investors have looked at the story, as they're newly public, but this will change as the company attends several upcoming conferences. We expect the market’s collective lightbulb to go off and that people will realize how undervalued this story is.
The stock trades at 2.2 times 2019 consensus enterprise value to earnings before interest, taxes, depreciation and amortization (EV/EBITDA), a 35 per cent free cash flow yield. This means the company could buy back all of the shares outstanding within three years, with the cash generated after maintenance capital expenditure requirements. FTS also will have no debt by next year.
We believe that the U.S. pressure pumping market will remain tight in 2018 and into 2019 and hence placing a sub-peak multiple on pressure pumping stocks is not appropriate. We've never seen valuations in the service sector this compelling when we weren't yet at peak margins/utilization. There's a lot of running room in service stocks in general and FTS is our largest service weight.
WPX ENERGY (WPX.N)
WPX is a U.S. Permian and Bakken light oil producer trading at a discount to peer averages despite high asset quality, an enviable inventory life index, reputable management, and an improving balance sheet that will reach peer-average leverage by the end of the year. Trading at 5.8 times 2019 EV/EBITDA, we see 50 per cent upside over the next two years. For Canadians looking for high-quality exposure to a mid-cap U.S. oil producer growing at 15 per cent and generating free cash flow, this is a solid pick (with takeout potential in 2018 or 2019).
PAST PICKS: JULY 19, 2017
TRICAN WELL SERVICE (TCW.TO)
- Then: $3.70
- Now: $3.12
- Return: -16%
- Total return: -16%
U.S. SILICON (SLCA.N)
- Then: $34.98
- Now: $28.28
- Return: -19%
- Total return: -19%
PARSLEY ENERGY (PE.N)
- Then: $29.13
- Now: $29.74
- Return: 2%
- Total return: 2%
Total return average: -11%