Following the second-quarter earnings season in Canada’s energy sector, Desjardins Securities analyst Chris MacCulloch thinks valuations are “becoming increasingly stretched,” however he still sees “upside from accelerated capital returns and strategic M&A.”
“Production shortfalls due to wildfire-related disruptions were the key theme for most producers under coverage,” he said. “Although there were limited changes to annual production targets, due in part to robust well results from winter drilling programs, several producers refined expectations toward the lower end of their respective guidance range. Notably, nearly every producer facing wildfire-related disruptions has since fully restored field operations and their respective capital program; this is expected to drive a modest production uplift through the balance of the year. Meanwhile, oil sands operators have also largely wrapped up planned maintenance turnarounds. There were a few notable ‘winners’ during the quarterly reporting session, with NVA, SDE, TOU and WCP all reporting strong cash flow generation which exceeded Street estimates. However, there were also a few ‘losers’, namely CVE and VET, which posted slightly disappointing CFPS relative to consensus expectations.
“As previously noted, capital returns across the sector are still gradually accelerating as corporate net debt targets are achieved and/or as companies gain scale, the latter of which resulted in dividend increases during 2Q23 reporting from ERF and TPZ. However, most producers continue prioritizing share buybacks for incremental capital returns, with a few even tapping revitalized balance sheets to accelerate repurchases prior to the renewal of NCIB programs. Going forward, we believe that sector consolidation will remain the key to unlocking accelerated capital returns as operational synergies are realized and improved efficiencies directly benefit shareholders. Following a relatively sleepy summer on that front, with a few notable exceptions, we believe M&A will dominate headlines going down the home stretch of 2023 as industry sentiment continues on the back of strengthening commodity prices.”
In a research report released Tuesday titled “After the boys of summer have gone”, Mr. MacCulloch reiterated his top picks for the sector. They are:
Integrated oil: Cenovus Energy Inc. with a “buy” rating and $31 target. The average on the Street is $29.78.
Large-cap natural gas: Arc Resources Ltd. with a “buy” rating and $25 target. Average: $23.53.
Mid-cap oil: Crescent Point Energy Corp. with a “buy” rating and $14 target. Average: $13.96.
Small-cap natural gas: Advantage Energy Ltd. with a “buy” rating and $13.50 target. Average: $11.95.
Royalty: Freehold Royalties Ltd. with a “buy” rating and $19 target. Average: $19.02.