Seniors are best energy plays - Financial Post, Nov.20: Talisman
By Sonita Horvitch
For investors in energy stocks, who are convinced the strength oil and gas prices is sustainable, the recent correction in the sector should be seen as a buying opportunity, says Jeffrey Francoz, president of MMI Group Inc. in Toronto.
"The way to play this is to choose senior oil and gas producers as these stocks offer some liquidity."
A value manager, Mr. Francoz seeks out stocks where the market has not fully recognized the underlying value of the company.
He says there has been unusual disparity between the price of commodities and the valuation of exploration and development companies since mid-August when oil and gas shares pulled back significantly. This left leading energy firms trading at cash-flow multiples that were comparable to those in place at the bottom of the energy cycle in February, 1999, before the dramatic recovery in oil and gas prices.
Mr. Francoz argues that the fundamentals "support stable, if not increasing energy prices." When it comes to oil, members of the Organization of Petroleum Exporting Countries are exercising "reasonable discipline in sticking to their production cuts." Furthermore, world reserves are declining, he says.
Gas is subject to different production and delivery dynamics. Pipeline infrastructure additions have ensured deliverability of Canadian-produced gas to the larger U.S. markets, which may result in demand exceeding existing supply. There is growing concern, he says, about a "burgeoning supply shortage due to the triple whammy of high decline rates on existing wells, low exploration and development spending over the past 18 months, and increased difficulty finding significant new reserves in the western Canadian sedimentary basin."
Mr. Francoz emphasizes senior producers, where he favours:
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Talisman Energy Inc. (TLM/TSE) $40 ($49.15-$22.10). This company, also in Calgary, is engaged in the exploration and development of oil and natural gas in Canada, the North Sea, Indonesia and the Sudan. It has exploration activities in Algeria, Trinidad and Peru. "The company has successfully combined both strategic acquisitions and internal exploration and development to enhance its oil and gas assets."
Mr. Francoz expects cash flow of $8.25 a share for 1999 and at least $10.50 for 2000. The stock is trading at a very modest multiple to its expected cash flow per share, says Mr. Francoz, "due to the political uncertainty surrounding its operations in the Sudan."
Should the recent appointment by Ottawa of John Harker to investigate Talisman's operations in the Sudan, result in conclusions that are unfavourable to the company, it could sell the assets "at a significant profit." At a cost to Talisman of about $750-million, its Sudanese assets represent 10% of its total oil and gas assets, he notes. "This is certainly a modest risk exposure to a very prolific region."
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