While the commodity benchmark is trading at a healthy enough level for market participants, there seems to be enough reason for the Zacks Oil and Gas - Exploration and Production - Canadian industry to notch substantial gains during the remainder of this year. In particular, the worldwide usage of Canadian crude is bolstered by production and export cuts from Saudi Arabia and Russia. While an inflationary environment and slowing economy might throw the space off track temporarily, investors might want to focus on Canadian Natural Resources CNQ, Crescent Point Energy CPG and Enerplus Corporation ERF for attractive cash flow and shareholder returns.
About the Industry
The Zacks Oil and Gas - US E&P industry consists of companies primarily based in the domestic market, focused on the exploration and production (E&P) of oil and natural gas. These firms find hydrocarbon reservoirs, drill oil and gas wells, and produce and sell these materials to be refined later into products such as gasoline, fuel oil, distillate etc. The economics of oil and gas supply and demand is the fundamental driver of this industry. In particular, a producer’s cash flow is primarily determined by realized commodity prices. In fact, all E&P companies' results are vulnerable to historically volatile prices in the energy markets. A change in realizations affects their returns and causes them to alter their production growth rates. E&P operators are also exposed to exploration risks where drilling results are comparatively uncertain.
3 Key Investing Trends to Watch in the Oil and Gas - Canadian E&P Industry
Growing Demand for Canadian Crude: Even as fears revolving around high inflation and slowing growth somewhat cloud the outlook for oil, the space continues to remain healthy. Apart from a positive fundamental picture, the sector has been enjoying support from production cuts by Saudi Arabia and Russia. As a matter of fact, WCS crude — the Canadian benchmark — hit a 10-month high above $70 recently. Experts point out that demand for Canadian crude is set to blossom further in the wake of the extension of Saudi Arabia and Russia’s voluntary production and export cuts.
Insufficient Pipeline Capacity: Energy consultant IHS Markit sees oil production in Canada surging by some 900,000 barrels per day during 2020-2030. Despite this impressive output growth expectation, the country's exploration and production sector has been out of favor, primarily due to the scarcity of pipelines. In short, pipeline construction in Canada has failed to keep pace with rising domestic crude volumes — the heavier sour variety churned out of the oil sands — resulting in an infrastructural bottleneck. This has forced producers to give away their products to the United States — Canada’s major market — at a discounted rate. Following U.S. President Joe Biden’s revocation of TC Energy’s contentious Keystone XL pipeline and the company’s subsequent termination of the project, Canadian oil sands producers will have to wait a little longer for the takeaway capacity issue to be resolved.
Returning Capital to Shareholders: The sharp increase in crude prices last year allowed Canadian upstream operators to deliver a solid financial performance. In particular, cash from operations is on a sustainable path, with revenues improving and companies slashing capital expenditures from the pre-pandemic levels amid higher commodity realizations. To put it simply, the environment of strong prices in 2022 helped the E&P firms to generate significant “excess cash,” which they intend to use to boost investor returns. In fact, more and more energy companies are allocating their increasing cash pile by way of dividends and buybacks to pacify long-suffering shareholders.
Zacks Industry Rank Indicates Positive Outlook
The Zacks Oil and Gas - Canadian E&P is an eight-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #87, which places it in the top 36% of nearly 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates fairly strong near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Considering the encouraging dynamics of the industry, we will present a few stocks that you may want to consider for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.
Industry Lags Sector & S&P 500
The Zacks Oil and Gas - Canadian E&P has performed worse than the broader Zacks Oil - Energy sector as well as the Zacks S&P 500 composite over the past year.
The industry has gone up 14% over this period compared with the broader sector’s increase of 19.3% and the S&P 500’s rise of 18.7%.
One-Year Price Performance
Industrry's Current Valuation
Since oil and gas companies are debt-laden, it makes sense to value them based on the Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization (EV/EBITDA) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of non-cash expenses.
On the basis of the trailing 12-month EV/EBITDA ratio, the industry is currently trading at 4.01X, significantly lower than the S&P 500’s 12.89X. It is, however, above the sector’s trailing-12-month EV/EBITDA of 3.46X.
Over the past five years, the industry has traded as high as 11.60X, as low as 2.48X, with a median of 4.58X, as the chart below shows.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
Stocks in Focus
Enerplus: An upstream operator, Enerplus focuses on Bakken and Three Forks formations in the Williston Basin in North Dakota, together with interests in the Marcellus Basin and waterflood projects in Canada. Banking on its low financial leverage and robust liquidity, Zacks Rank #1 (Strong Buy) ERF is in a pole position to take advantage of the sharply higher commodity prices.
The Calgary-based company is valued at some $3.5 billion. Over the past 30 days, Zacks Consensus Estimate for 2023 earnings has moved up 14.1%. ERF shares have gained 32.8% in a year. You can see the complete list of today’s Zacks #1 Rank stocks here.
Price and Consensus: ERF
Canadian Natural Resources: This Calgary-based energy major boasts a diversified portfolio of crude oil (heavy as well as light), natural gas, bitumen and synthetic crude oil. CNQ’s balanced and diverse production mix facilitates long-term value and reduces risk profile, thereby lending its results a high level of stability. Lower capital expenditure needs, accretive acquisitions and improving operational efficiencies are the other positives in Canadian Natural’s story, allowing the company to generate a significant free cash flow of C$10.9 billion (post capital spending and dividends) in 2022.
Notably, over the past 30 days, the Zacks Consensus Estimate for CNQ’s 2023 earnings has moved up 5.3%. Canadian Natural shares have gained 39.8% in a year. The stock carries a Zacks Rank #3 (Hold).
Price and Consensus: CNQ
Crescent Point Energy: This Calgary-based company, whose operations are primarily concentrated in southwest and southeast Saskatchewan, carries a Zacks Rank of 3. Crescent Point, which acquired Shell’s Alberta assets for C$900 million last year, counts operational excellence and prudent cost management as its strengths. With a low-risk drilling inventory of long-life assets and strong market access, CPG is also making progress on balance sheet strength and shareholder return initiatives.
Over the past 90 days, the Zacks Consensus Estimate for Crescent Point’s 2023 earnings has moved up 6.6%. The company’s Value and Momentum Score of A each help it to round out with a VGM Score of A. With a market capitalization of around $4.2 billion, CPG has gained 41.2% in a year.
Price and Consensus: CPG
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