August 16, 2023
Canadian E&P Perspectives
Junior & Intermediate E&Ps: NAV Sensitivities
Our view: Amid the close of Q2 reporting and ongoing price volatility, we have refreshed NAV sensitivities across the Canadian SMID-cap universe alongside our view of what commodity prices the market is currently pricing in. We continue to believe investors remain focused on return of capital and free cash flow generation, though duration and drilling inventory remain key considerations, with producers putting incremental capital into asset delineation and/or pursuing M&A. In our view, industry consolidation likely continues alongside the pursuit of operating scale and improved efficiencies, though valuation markers have moved higher. Based on our current estimates, we believe the broader group is pricing in roughly US$65/bbl WTI, which compares to 2023/24 strip pricing at US$78/US$78.
Canadian SMID-caps pricing in roughly US$65/bbl WTI. Based on our updated estimates, we believe producers are pricing in long-term WTI prices in the range of US$55-$80/bbl as outlined in Exhibit 1; this comes in US$12/US$13/bbl below 2023/24 strip pricing and US$16 below the front month at US$81/bbl. While we are seeing greater dispersion in valuations within the producer group, we continue to believe the sector remains undervalued with further multiple expansion likely driven by increased confidence in commodity price durability and M&A, among other factors. Producers have broadly maintained financial discipline with balance sheets and FCF metrics remaining strong, though current valuation markers (P/ NAV, EV/DACF) continue to trail historical levels (Exhibit 6).
NAV sensitivities; framing torque to commodity moves. We have run a series of sensitivities outlined in Exhibits 2-3, with producers exhibiting an 18% average impact to 2P base NAVs on a US$10/bbl increase to WTI and a 10% average impact on a US$0.50/MMBtu increase to Henry Hub. Producers most sensitive to a US$10/bbl increase to WTI include GTE, CJ, OBE, and ATH with the least sensitive including AAV, TOU, and PEY. Producers most sensitive to a US$0.50/MMBtu increase to Henry Hub include PIPE, AAV, and PEY with the least sensitive including GTE, ATH, and PXT. We have also outlined various price scenarios (Exhibit 4) to indicate fundamental asset values at various commodity price outlooks.
Asset duration increasingly in focus. Producers broadly continue to exhibit strong capital discipline with sustainability metrics improving over the last several years, supporting return of capital balanced with moderate growth (recent note here). Asset duration is increasingly in focus for investors with companies pursuing this through organic delineation efforts and/or M&A. On average, producers in our coverage universe exhibit reserve life index (RLI) figures of 6/14/24 years on the basis of PDP/1P/2P reserves (Exhibit 5). Gas weighted producers generally screen better from an inventory perspective with plays like the Montney offering stacked pay with decades of inventory. Standouts on a 2P RLI basis (>30 years) include ATH, BIR, KEL, and CR, with TVE, PXT, and HWX screening among the lowest at sub-10 years.
Producers remain in strong financial positions. E&Ps are broadly in healthy financial positions with aggregate net debt falling by ~$3.1 billion from year-end 2021 to year-end 2023 on our estimates; financial leverage now maps to 0.7x/0.5x D/CF in 2023E/24E, on average. Producers have generally outlined capital programs supporting moderate growth in order to maintain sustainable production profiles and maximize free cash generation to fund shareholder returns. In our view, the broad shift in operating philosophy has resulted in an unprecedented level of resiliency for the industry that will likely draw incremental investor interest over time.
Top ideas. Our top ideas feature what we believe to be favourable long-term sustainability, RoC metrics, and top-decile assets, though not necessarily the most “torque” to commodity prices. We highlight ARC Resources, Topaz Energy, and Tourmaline Oil, as highlighted in RBC's latest Global Energy Best Ideas list.