More NuttallExtract from Friday's National Post article. GLTA
Geographically, I believe the best opportunities on the planet are in Canada, given a profound mispricing of long-dated, low decline resources with a positive macro rate of change given the build-out of one million barrels per day of incremental pipeline takeaway capacity over the next year and change. The average Canadian exploration and production companies possess about 16 years of risked inventory, yet given the egregious levels of free cashflow being generated at the current oil price, could privatize with only five years of free cashflow.
I’m most excited about smaller Canadian oil companies given their depressed valuations, with those that I follow trading at an average enterprise value to cashflow multiple of only 2.9 times, compared to a historical level of seven to nine times.
Cheap stocks can stay cheap forever, however, without an identifiable catalyst and given that nearly all management teams have committed to returning at least 50 per cent of 2022 free cashflow back to shareholders, this portends returns of approximately 12 per cent at US$70 West Texas Intermediate, and 15 per cent at US$80.
I believe that once promised returns in the form of dividends and buybacks become reality, companies will successfully force the rerating of trading multiples from such incredibly low levels.
What upside does this suggest? Using a targeted free cashflow yield of 10 to 15 per cent, the average energy stock I follow would have a 58 per cent upside from current levels using a US$70 WTI oil price, and 85 per cent upside using US$80 WTI. Naturally, an active energy fund manager would strive to do better than the “average,” especially in what has become an incredibly inefficient and alpha-rich environment.
How can such valuation dislocations still exist?
Energy ignorance, the lack of knowledge of the likely timeline of alternatives to displace the use of oil, is allowing investors today to be able to invest in an energy company and literally get 11 years of free cashflow for nothing, given the market’s current unwillingness to place value on barrels set to be produced in later years.
Imagine you could buy a maker of widgets, with 16 years of inventory sitting in a warehouse, whose margins from the current price of widgets would allow it to go private in only five years. Would this not seem like a generational investment opportunity, especially when the price of widgets was likely to meaningfully rise in the coming years? That is the current state of Canadian oil and gas valuations.
Back to connecting the dots: supply growth constraints in a world in which demand will continue to grow for years to come means that global oil inventories will continue to fall, placing meaningful upward pressure on the price of oil, until such time as it becomes too costly for discretionary uses and therefore kills marginal demand.
This price level would suggest an oil price in excess of US$140 WTI. With energy stocks only discounting an oil price of approximately US$60 WTI, energy investors are getting free optionality on a multi-year bull market and the inevitable re-rating of the energy stocks.
Eric Nuttall is a partner and senior portfolio manager with Ninepoint Partners LP.