Cheap oil, gas stocks spell boycott: analysts
Firms urged to improve return on investment, or prices will continue to languish
The Globe & Mail, Thursday January 13
STEVEN CHASE, Alberta Bureau
Calgary -- The cheap prices assigned to Canadian oil and gas stocks
amount to a boycott of the sector by capital markets, which are
waiting for energy firms to improve return on investment for
shareholders, analysts say.
"Basically, [equity] capital went on strike," says Greg Pardy, who
follows Canadian oil and gas producers for Goldman Sachs & Co. in
New York.
Analysts caution the days of easy access to share capital are over for
many in the Canadian oil patch, and they predict companies will be
forced to sweeten rates of return to woo back investors, who now
have far more options for where to put their money.
These warnings come as many oil and gas producers in Canada are
scratching their heads at what they consider undervalued energy stock
prices, despite strong crude and natural gas prices.
"Despite favourable fundamentals, Canadian [exploration and
production company] valuations have traded down to levels that give
a new meaning to the word inexpensive," Mr. Pardy and colleagues
say in a recent paper on the sector.
The Toronto Stock Exchange's oil and gas subindex has sagged more
than 16 per cent since hitting a 52-week high late last summer, despite
what analysts call the best combination of oil and gas prices in recent
memory. Share prices of energy companies are trading at discounts of
several times cash flow.
Some of the reasons for these discounts are habitual commodity
worries. Investors are nervous that crude prices will fall if the
price-setting Organization of Petroleum Exporting Countries jacks up
production this spring. Plus, the 1999-2000 winter is shaping up to be
the third warmer-than-average winter in a row, a move that has
caused natural gas prices to pull back significantly from 15-year highs.
The "capital strike" isn't as bad for the huge Canadian oil and gas
producers, who have an easier time raising money. They could see
their shares jump if healthy oil and gas prices survive in 2000.
But analysts warn that investor restlessness is a permanent problem
that has raised the bar for oil companies looking for equity.
Technology stocks have taken the lead among speculative
investments, and investors are putting in far more money abroad in the
wake of new registered retirement savings plan-eligible funds that get
around the 20-per-cent foreign content limit on RRSP portfolios.
This tidal shift is the undoing of the oil and gas sector, which saw
junior and intermediate companies flourish in the late 1980s and early
1990s on the strength of easy access to capital and a steady sale of
assets by retreating majors. The share capital came from the growing
mutual fund industry, which provided increasing amounts of it, says
analyst David Stenason of Scotia Capital Inc. in Montreal.
"My opinion is the industry has poorly understood the true cost of
equity capital. . . . You don't receive this for free: You must generate
a return for it or the equity gets taken away."
Unfortunately, the track record of the oil patch has proven dismal for
the past half-decade, analyst statistics show. On average, exploration
and production companies have generated a rate of return of around
5 to 6 per cent.
For years, profitability has taken a back seat to growth as companies
scramble to boost production in an increasingly tapped-out geological
basin, where the easy pickings are disappearing, analysts say.
The low, single-digit returns pale in comparison to other sectors, such
as the banks, which earn in the 15-per-cent range, and technology
companies, which reward investors with 17 to 25 per cent, Mr. Pardy
says.
"If an oil company can't generate a [10-per-cent-plus] rate of return,
then why should anybody invest in them?" he says.
For companies, this means reining in capital spending, so instead of
forking out several times cash flow in a good year to grow quickly,
they take a more prudent approach.
For some it will mean buying back shares, as Anderson Exploration
Ltd. and Crestar Energy Inc. have done, to boost the value of their
stock.
Companies that analysts say manage to effectively juggle growth and
profitability include Penn West Petroleum Ltd., and Rio Alto
Exploration Ltd. Others that make the grade include Talisman
Energy Inc., and Anderson and Canadian Hunter Exploration Ltd. |
