Jul 19, 2017

Eric Nuttall's Top Picks: July 19, 2017

BNN Bloomberg

Eric Nuttall , BNN

Eric Nuttall, portfolio manager at Sprott Asset Management

Focus: Energy stocks
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MARKET OUTLOOK
Purgatory. That is the word that best describes what the energy markets feel like at the moment. Good news is being entirely ignored and negative data points bombard investors on a daily basis, leading to the strongest negative feedback loop since January 2016 when oil was in free-fall to $26/bbl.

The past two weeks have seen two extremely positive DOE oil inventory reports, and yet oil has essentially traded flat or down on the news (this week’s oil draw was the largest since September 2016 and was four times better than consensus). Headlines like “Oil glut continues,” “U.S. production surges,” “OPEC compliance falls,” “Volvo to discontinue conventional engines by 2019,” have become daily events. This constant negativity has led to energy stocks falling for seven consecutive months in a row — something that hasn’t occurred in at least 27 years (as far back as available data goes).

This seven-month selloff has exhausted most investors’ patience and is resulting in a buyers’ strike whereby stocks can fall to ridiculously inexpensive levels (much more on this later). At the same time, algo and quant funds continue to press their short bets (example: FMSA short position has risen from 15 million shares in March to 46 million shares in June and now equates to 30 per cent of the float with quants representing the majority of the short increase, according to Morgan Stanley).

Sentiment remains the worst that I have ever seen in my career. Oil fundamentals have undoubtedly deteriorated over the past six months given a ramp-up in Libyan and Nigerian oil production, a sharp rebound in U.S. drilling activity, and a mismatch between OPEC production cuts and OPEC export cuts.

However, despite these headwinds inventories continue to fall, and the oil market could rebalance by the end of Q1 2018. We remain bullish crude and believe oil will trade above $50/bbl in the coming months, and therefore we should see very material upside in energy stocks.

TOP PICKS

TRICAN WELL SERVICE (TCW.TO) – Last purchased on April 27 at $3.80
The demand for Canadian pressure-pumping services continues to exceed available equipment and crews, resulting in continued pricing increases. We think in a $50/bbl world, TCW can post EBITDA of $300 million, and when ascribing reasonable value for its U.S. investment in FRAC:US, the stock is trading at 3.4x EV/EBITDA versus a mid-cylcle valuation of 6.5x to 7x. We see TCW as a $6 to $7 stock in 2018.

U.S. SILICA HOLDINGS (SLCA.N) – Last purchased on June 14 at $34.38
The demand for frac sand continues to exceed available supply in the U.S. Leading edge well design in major basins continues to use more and more proppant, resulting in demand for frac sand equating to 75 million tons in 2017 growing to 100 million to 110 million tons in 2018 and potentially 140 million tons in 2019. While supply is growing, we still see an undersupplied market for the next two years. With the selloff in oil, frac sand names have been decimated with stocks falling by 40 per cent to 70 per cent YTD. SLCA is the best positioned frac sand company in North America with net cash on the balance sheet, a diversified product mix, and a respected CEO. The stock trades at 4.6x 2018 consensus versus a typical multiple of 8x. We see over 50 per cent upside in this name over the next year.

PARSLEY ENERGY (PE.N) – Last purchased on June 9 at $27.77
Parsley is a pure play Permian producer that has grown by 16 per cent per quarter over the past three years and has the goal to grow by 50 per cent per year for the next three years, spending cashflow at $50/bbl. While they have been aggressive acreage acquirers, their focus can now turn to production optimization and delineating new benches including the Wolfcamp C, where they drilled an outstanding well with the potential for 900 locations. With the potential for 15 years of Tier 1 inventory, PE is very well positioned in some of the best rock in the best play in North America.