The S&P 500 market cap has doubled since 2014, yet energy as a percent of the S&P is at its lowest on record at ~4%. We believe this is set to move higher as money chases performance and profitable businesses are trading at low valuations. The sector’s outperformance is fuelling the fire with index additions. Close to half the additions to the MSCI Canadian and MSCI Canadian Small Cap indexes last week were energy companies.
Arc Resources’ (ARX) addition to the MSCI Index on a net basis will result in 22 million shares of demand. On a fundamental basis, Arc’s market cap today is the same as 2014, at $10 billion. Yet Arc is a 350,000 boe/d company today, up from about 120,000 boe/d in 2014, with a valuation of just under 3x EV/DACF compared to >12x eight years ago. Unlike in 2014 when the company was ramping up production and spending 120% of cash flow, today Arc is buying back 10% of its public float, paying a fixed dividend (2.4% yield), paying down debt, and has low single-digit production growth.
These valuations exist with major energy security risks around the globe, as LNG Canada is set to come on stream in the next few years, and the basin resembles more of an oligopoly – the top five producers control >50% of the natural gas market compared to 30% pre-pandemic. The stars are aligned for the energy sector with strong fundamentals and fund flow tailwinds. But most importantly, investors can gain exposure to the sector at unprecedented valuations and record low market representation, which could reduce risk as the sector moves through the life cycle.
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