A must read article in the Financial Post:
A winning hand
Play your cards right, and an investment
in Canada's oil and gas sector could make
you a killing
Ian McKinnon and Claudia Cattaneo
Financial Post
In an industry where
value is usually as
smudgy as a seismic line,
analysts say Canadian
oilpatch fundamentals
are so good most picks
should ride the bull to
easy profits in the next
six to 12 months.
While the low-hanging
fruit has been plucked,
as reflected by a 72%
rise in the Toronto Stock
Exchange oil & gas
subindex since this year's
low on March 2, the
next spurt will be fed by
smaller companies
focused on natural gas
low-cost operators,
producers with major
growth projects up their
sleeve and successful
acquisitors, analysts say.
"We think we're in the very early stages of the bull market," said
Wilf Gobert, director of research at Peters & Co. Ltd. in Calgary.
"Now it's a question of identifying companies that are going to enjoy
the best volumetric growth or the best improvement in profitability."
The turnaround has been driven by a combination of rising oil and
natural gas prices, low costs, narrow heavy oil differentials and
renewed institutional interest.
"It's entirely possible that we could establish a new record high this
time. We think there is still 20% or 30% upside from here," said
Gord Currie, an analyst with Canaccord Capital Corp. in Calgary.
Oil prices have almost doubled in the past five months, closing
yesterday at $21.65 (US) a barrel in New York, since members of
the Organization of Petroleum Exporting Countries agreed to slash
production. Natural gas prices, fuelled by a mercury-busting
summer in much of North America, have reached unprecedented
levels and no let-up is foreseen over winter.
"We consider we are still in the 'virtuous' growth phase of the cycle,
which is the best part. It's usually characterized by expanding cash
flow multiples, declining financial leverage, increasing capital
expenditure programs and accelerating production, earnings and
cash flow growth," said Greg Pardy, who follows Canadian oils at
Goldman Sachs & Co. in New York.
In a recent study, Martin Molyneaux, research director at
FirstEnergy Capital Corp. in Calgary, estimated that earnings for the
80 companies it follows, which produce about 80% of total
Canadian oil and gas production, will hit $2.1-billion in 1999, rising
to $2.6-billion next year. In 1998, the group lost $1.6-billion.
Industry drilling is expected to surge to 14,700 wells next year, from
about 10,500 this year. Mr. Molyneaux said 2000 "is shaping up as
the best year this decade."
As always, the wild cards that could stall the rally are OPEC
maintaining cuts, the weather and the health of the economy.
"If oil prices went down, they would take gas prices with them, to a
lesser degree. So that is your risk element. But if prices hold, there
is probably another 20% potential for capital appreciation in this
group," said David Stenason, director of oil and gas research at
Scotia Capital Markets in Montreal.
The torch has been carried by senior companies with a market
capitalization exceeding $1-billion. "If you look at traditional
valuation ranges, our view is that we see better opportunity in the
seniors, and these companies tend to be more oil-weighted," said
Mr. Pardy.
Workhorses like Talisman Energy Inc. (up 68% to mid-August)
Alberta Energy Co. (up 45%) and Canadian Natural Resources
Ltd. (63%) are top picks of many analysts. Although they have
already chalked up double-digit increases, there's more potential for
stock appreciation because of swelling cash flows, new projects
and upside of recent acquisitions.
Canadian Hunter Exploration Ltd., Crestar Energy Inc., Penn West
Petroleum Ltd., Paramount Resources Ltd., Petro-Canada,
Renaissance Energy Ltd. and Rio Alto Exploration Ltd. are among
the favourites.
Some of these wealthy players are known to be looking for
acquisitions. Mr. Molyneaux said 10 companies interested in taking
over the BP Amoco's Canadian oil assets will now be searching to
buy other targets after Canadian Natural and Penn West scooped
the prized properties by launching a surprise cash bid of
$1.6-billion. Companies like AEC, Petro-Canada, Renaissance and
Talisman are known to be on the hunt.
Trailing the large caps are the intermediates and the juniors, which
are likely to post the largest gains as the cycle progresses. "There is
still room in intermediates, and the risk profile is lower, but if you
want to make multiples and are willing to take risks, should you go
to juniors," said Mr. Stenason.
Oilpatch analysts use a variety of methods to assess value and
separate hidden gems from flawed jewels. They range from
assessing exploration programs, finding and development costs,
management depth, hedging programs and production growth.
But some names surface on several lists, with many of them oriented
to gas. These firms include Trigas Exploration Inc., Ionic Energy
Inc., Velvet Exploration Ltd., Richland Petroleum Corp., Magin
Energy Inc., Post Energy Corp., Genesis Exploration Ltd.,
Compton Petroleum Corp. and Cypress Energy Inc. Other
perennial favourites are Berkley Petroleum Corp., Bonavista
Petroleum Ltd., Encal Energy Inc. and Anderson Exploration Ltd.
Risk-averse investors looking for blue chips that throw off steady
dividends should stick to pipeliners such as TransCanada PipeLines
Ltd. and Enbridge Energy Inc.; producers such as PanCanadian
Petroleum Ltd. and Alberta Energy; integrated oil companies such
as Imperial Oil Ltd., Suncor Energy Inc., Petro-Canada and Shell
Canada Ltd.
Bottom feeders searching for value in potential targets should watch
for companies that are failing to meet projections, have large debts,
high costs or have lost the confidence of the Street. Analysts say
companies sitting in the penalty box include: Cabre Energy Ltd.,
Canadian 88 Energy Corp., Founders Energy Ltd., Newport
Petroleum Corp., Ranger Oil Ltd. and Tri Link Resources Ltd.
"If you can buy good value, there are really two ways you can win,"
Mr. Currie said. "One way is the company gets taken over by
somebody, and the other way is if there is some change in the
fundamentals that just allows it to perform better and the market
evaluation creeps up a couple of points."
Another option is to look for energy firms that are unlikely takeover
targets because of large control blocks. A high-valued producer
could use its stock to pay for a friendly deal and reward patient
investors. Beaten-up firms such as Numac Energy Inc. and Summit
Resources Ltd. are in this class. .
As high commodity prices increase cash flow for producers, money
will eventually flow into the pockets of service firms this winter and
in 2000 as firms boost drilling to find new reserves.
Some service firms are already saying higher fees are on the way,
but Peter Tertzakian, analyst with Goepel McDermid Inc., said
capacity added during the last drilling boom will keep pressure on
day rates even as activity increases. He said technology-oriented
firms such as NQL Drilling Tools Inc., Ryan Energy Technologies
Inc. and Tesco Corp. are already fully valued, but players with
more upside potential include Enerflex Systems Ltd., Pason
Systems Inc., Mullen Transportation Inc., Shaw Industries Ltd. and
Trican Well Service Ltd.
"We're in a momentum market but people should be aware that the
risk-reward ratio is not as compelling as it used to be," he said.. |
