Paradigm Ahead of first-quarter earnings season, Paradigm Capital analyst Adam Gill thinks there’s more interest in Canadian junior oil producers than he’s “seen in a while.”
“Valuation is driving the renewed interest in the space,” he said. “Thus, there could be some room for these stocks to see a nice run, given there is limited credit in the space for US$80/Bbl WTI persisting. Based on the strip price forecast, we see the broader junior oil group trading at a 2.7 times 2024 estimated EV/DACF [enterprise value to debt-adjusted cash flow] yield with a 14-per-cent median FCF yield. That said, if we run US$80/Bbl flat in 2024, the valuation drops to 2.2 times with the FCF yield moving up to 17 per cent. That said, to get back to valuations on strip it would imply 25-per-cent share price upside for the group on average. If oil continues to hold and confidence in the price improves, this area could see a nice run-up.”
Mr. Gill said his focus will be on how gas producers adjust their development programs to recent price weakness, believing that will be “key to becoming more constructive on the price environment.”
“While it seems that gas prices have bottomed out, we still want to see more done on E&P capital reductions before becoming bullish on the space,” he added. “The storage overhang is substantial and there is demand risk given recession concerns. Also, valuations for the gas E&Ps are still elevated in our view, so we believe the market is looking through the current low prices.”
“The most consistent theme while marketing was if it was time to long gas names. That said, we are not quite there given: 1) There is a lot of excess storage today and even with solid summer demand it is hard to see us in a deficit into winter 2023/2024, and this becomes more challenging if we see some recession pressure on electrical generation and industrial demand. Thus, there is likely limited upward pressure to the 2024 strip; and 2) The gas names have been looking through much of the near-term weakness with a ramp-up in valuations and depression of FCF yields versus the oils which have been stable.”
Mr. Gill said there are two names in sector that are “solid investment opportunities” currently. They are:
* ARC Resources Ltd. with a “buy” rating and $23 target. The average target is $22.44.
“With the B.C. government and Blueberry River First Nations reaching an agreement on the approach to land, water and resource stewardship, we are looking for larger development projects to start to move in the province,” he said. “That said, the market has been waiting for ARC to move forward with the first development phase at the liquids-rich Attachie Montney play, and we believe sanctioning the project will start driving some recognition of the potential. The project is expected to take $700-million to bring on-stream 40 MBoe/d of new volumes (25 MBbl/d of C5+/NGLs and 90 MMcf/d of gas). Based on current strip prices, we see this project reducing ARX’s EV/DACF valuation to 2.6 times in 2025 from 3.6 times in 2024. Thus, the share price would need to appreciate to $23.50 to return to a 3.6 times valuation, which would imply an annualized 19-per-cent return over the next two years from the current $16.61 level (before the 3.6-per-cent annual dividend yield).”