Eric Nuttall, partner and senior portfolio manager, Ninepoint Partners

FOCUS: Energy stocks 

MARKET OUTLOOK:

Energy investors have ridden the rollercoaster of volatility this year, contending with relentless worries of recession, a White House seemingly determined to do whatever it takes to lower the oil price and surprisingly high non-OPEC production growth from the U.S. and Russia. Inventories have fallen significantly this year, but not as aggressively as initially thought, owing to U.S., Russian, and Iranian production growing more than expected despite demand growth of around 2.4 million barrels per day.

Looking to 2024, we see ongoing demand growth albeit at a moderated pace (one to 1.5 million barrels per day) and more moderate non-OPEC production growth, leading to global oil inventories that should continue to fall. With ample OPEC spare capacity for the next year or two, we see little chance of oil trading meaningfully above US$100 West Texas Intermediate (WTI), though given that global oil inventories currently sit at multi-year lows, we do see a strong fundamental floor of around $80 WTI.

In an $80 to $100 WTI range, energy stocks offer meaningful potential upside. With final debt targets being reached in early to mid-2024, we see companies returning upwards of 100 per cent of their free cash flow back to investors. In Canada, the christening of both the TMX expansion and LNG Canada should see meaningful incremental offtake for both oil and natural gas, leading to improved pricing for Canadian producers. With average free cash flow yields of 13 per cent (some close to 25 per cent) at $80 WTI and an average return-of-capital yield of 10 per cent yield in 2024, we see compelling value in many names.

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TOP PICKS:

Precision Drilling (PD TSX)

PD has been aggressively paying down debt over the past several years, resulting in debt falling from unacceptably high levels to around one times earnings before interest, taxes, depreciation and amortization (EBITDA) by the end of 2024. As leverage approaches a more reasonable level, we see the company pivoting from paying down debt with its free cash flow to returning it more meaningfully to shareholders. We estimate the company to trade at a 34 per cent/36 per cent free cash flow yield in 2024-25, with the company thus theoretically able to privatize in only three years’ time (with non-depleting assets). We have in the past several weeks bought around 9.9 per cent of the company, and our target multiple is five times EBITDA which = a 14 per cent free cash flow yield (to equity) = $177 potential share price = 127 per cent potential upside.

Crescent Point Energy (CPG TSX)

Crescent Point recently bought Hammerhead, a high-quality Montney producer that was largely held by Rivestone, a private equity investor. While the deal had strong strategic merits (free cash flow accretive by 11 per cent, increased Tier 1 inventory to 20 years of drilling), it required equity financing which was poorly timed on the eve of oil selling off by $3 per barrel, resulting in a hung deal. While the deal overhang was taken care of, people have misinterpreted it as being a “bad deal” versus “bad timing.” With the stock trading at a 24 per cent free cash flow yield and 60 per cent of free cashflow (now 11 per cent higher than before the deal) being returned to investors we see the stock as being profoundly mispriced. Our target multiple = five times CF = 12 per cent FCF yield at $80 WTI = $19.50 target price. We have bought more stock subsequent to their deal and now own 19 million shares.

Cenovus (CVE TSX)

Cenovus has been relentlessly trying to get to their ultimate $4 billion debt target which will trigger 100 per cent of free cash flow being returned to shareholders, and while this has taken about a year longer than expected due to weaker-than-expected oil pricing and downstream challenges, we see this milestone being reached at the end of the first quarter of 2024. Trading at a 16 per cent free cashflow yield at $80 WTI we see the potential for meaningful share buybacks to re-rate the stock from its current trading multiple of 4.1 times. We have a target multiple of six times = 10 per cent FCF yield at $80 WTI = $37.40 share price.