Q3/21 Preview
Commodity Prices Continue to Move Higher
D&C Activity Forecasts Increase; Introducing 2023 Estimates
TD Investment Conclusion
Making Upward Revisions to Our Industry Forecasts: In concert with our recent commodity price deck update (full report), we are making modest upward revisions to our Canadian and U.S. industry forecasts. In our view, the current strength in commodity pricing is an acknowledgement that there are no broad expectations of a significant North American supply response. To the contrary, our review of publicly traded North American E&P commentary suggests that these companies will pursue modest production growth, while prioritizing increased dividends, share buybacks, and debt repayment. There are examples of producers rationalizing higher spending/drilling and completions (D&C) activity, while continuing to appease investor demands for capital discipline and anecdotes of much higher spending from private companies. The increases in our industry forecasts reflect these changes. Details on page 3.
Q3/21 Preview: Canadian drilling activity was very strong at the start of Q3/21 due, in part, to dry field conditions, but that momentum failed to build throughout the quarter. Conversely, the U.S. market continued to see small, but consistent increases in activity as the quarter progressed. Overall, updates to our estimates heading into the quarter are relatively limited. We expect that several companies could increase their dividend with Q3/21 results or in the near term, with Enerflex and North American having the highest likelihood, in our view.
Our Sector Stance: MARKET WEIGHT
On page 2, we show that share-price performance for our coverage universe continues to correlate with WTI pricing, whereas the U.S. rig count, and North American D&C activity more broadly, continues to significantly underperform. As a result, we believe that investors have already priced-in a strong sector recovery for companies with high D&C exposure. As a result, our best ideas for oilfield services sector exposure continue to focus on companies with a combination of recurring and/or production-weighted revenue profiles, capital-light business models, strong growth outlooks, attractive free-cash-flow generation, and positive ROIC. Among them, we highlight Secure Energy Services (SES-T, BUY, $8.00 target price) as our top pick. Although share-price performance has been strong in recent weeks, Secure remains fundamentally mispriced, in our view, following the acquisition of Tervita (full report), given the improved competitive landscape of its core business, its ability to achieve meaningful transaction synergies ($75 million), its free-cash-flow-generating capabilities and the relative stability of operating and financial performance. Q3/21 represents the first combined quarter for Secure and Tervita, and we expect the stock to outperform once the positive deal attributes noted above are realized. At the current share price, Secure is also a likely candidate for S&P/TSX Composite Index inclusion, separating the company from the rest of the coverage universe from a market-relevance perspective, in our view.