Eric Nuttall, partner and senior portfolio manager, Ninepoint Partners

FOCUS: Energy stocks

MARKET OUTLOOK:

Despite the recent selloff in oil driven by rising fears of a global recession and the potential impact on demand, we remain in a multi-year bull market for oil. With the largest release from strategic petroleum reserves in history coming to an end in the next few months and China eventually emerging from COVID-19 lockdowns, we see the oil market further tightening from an already undersupplied situation. This is evidenced by continued falling global oil inventories. We believe we are in an era of “higher” energy prices and continue to use US$100 West Texas Intermediate (WTI) in our base case modelling and stock picking for 2023.

The state of the Canadian energy sector is simply incredible: record free cash flow, low-to-no debt, and a commitment to return 50-100 per cent of free cash flow back to shareholders in the coming year. With the sector trading at an estimated 29 per cent free cash flow yield at US$100 WTI, we see the likelihood of continued share buybacks and meaningful variable dividends in the coming quarters, driving a re-rating of valuations from the historic low of 2.5x EV/CF. We remain bullish.

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TOP PICKS:

MEG Energy (MEG TSX)

MEG energy, a pure play oil sands producer, has 35 years of stay-flat reserves and trades at a 30 per cent free cash flow yield, thus able to privatize in just over three years. Investors then are getting 32 years of free cash flow for free, equivalent to $40 billion of undiscounted free cash flow. With the company set to hit its ultimate debt target by third-quarter 2023, leading to 100 per cent of free cash flow being returned to investors, we have the company able to buy back 42 per cent of its stock by the end of 2024. At this time the company would then be able to pay a 45 per cent dividend per year for the next 30+ years. We peg fair value at $41/share = 120 per cent + potential upside.

Baytex Energy (BTE TSX)

Baytex has drilled nine of the 10 best wells in the Clearwater play, the most economic oil play in North America, with wells paying out in about one month. Trading at 1.8x EV/CF and a 39 per cent free cash flow yield at US$100 WTI, we do not think the market is ascribing a deserved premium (or even market) multiple for its asset quality. With the company rapidly deleveraging, hitting its next debt target by first-quarter 2023, Baytex will be able to buy back 99MM shares in 2023 at the current share price = 18 per cent of shares outstanding. We think fair value = 5x = $19.47 = 197 per cent potential upside at US$100 WTI.

Tamarack Valley (TVE TSX)

Tamarack recently announced a material bolt-on acquisition in the Clearwater play from ARC Financial for $1.4 billion. While this transaction defers its ability to return meaningful free cash flow back to shareholders by about two quarters given the need to deliver, assets of this quality and running room rarely come to market. As a result, Tamarack is now the dominant public Clearwater player with 12+ years of running room in the most economic oil play in North America. We estimate the stock to be trading at 2.1x EV/CF and a 44 per cent free cash flow yield, able to buy back 12 per cent of its stock in 2023 while paying a four per cent dividend and peg fair value at 5X = $11.66/share = 195 per cent potential upside.

PAST PICKS: September 24, 2021

Whitecap Resources (WCP TSX)

• Then: $6.44
• Now: $9.18
• Return: 43%
• Total Return: 48%

Cenovus Energy (CVE TSX)

• Then: $12.12
• Now: $24.10
• Return: 99%
• Total Return: 101%

Enerplus (ERF TSX)

• Then: $9.09
• Now: $20.23
• Return: 123%
• Total Return: 125%

 Total Return Average: 91%