Desjardins Top Pick Alongside a “rough start” to 2024 for the Canadian energy sector with “commodity price weakness driving sluggish equity market performance,” Desjardins Securities analyst Chris MacCulloch expects similar turbulence through upcoming fourth-quarter 2023 earnings season as “softer cash flow generation (relative to 3Q23) and operational hiccups from the mid-January deep freeze come to light.”
“Although we remain constructive on the sector given improved industry resiliency from balance sheet strength and an unwavering commitment to returning the lion’s share of FCF to investors, we have trimmed price targets for nearly every producer under coverage, which is primarily a reflection of our reduced commodity price forecast,” he said,
“We have updated our estimates ahead of 4Q23 reporting, which should be highlighted by strong operational results for most producers given the mild temperatures experienced throughout the basin (until January), offset by softer quarterly cash flow following the moderation in commodity prices. That said, the sector is well-positioned to weather nearterm volatility, with defensively positioned balance sheets following several years of debt repayment and the lion’s share of industry FCF now allocated to capital returns.”
In a research report released Tuesday, he cut trimmed his 2024–25 Brent and WTI forecast by US$5 per barrel each to US$80 and US$75, respectively, to reflect a “cautious” near-term economic outlook.
“Our revised price deck better aligns with our view that WTI prices will remain range-bound at US$70– 80/bbl until the next major shoe drops, either from a macroeconomic or a geopolitical perspective,” said Mr. MacCulloch. “Although we remain optimistic on the prospect of TMX linefill commencing in 2Q24 following the CER’s recent granting of a minor project variance, we have slightly widened our 2024 WCS–WTI differential forecast to US$16/bbl (from US$15/bbl). We have also cut our 2025 New York Harbor 3-2-1 crack spread forecast to US$17.50/bbl (from US$20.00/bbl), reflecting our cautious longer-term outlook.”
For large-cap stocks, the analyst’s target changes are:
- Arc Resources Ltd. (ARX-T, “buy”) to $29 from $31. The average is $26.70.
- Canadian Natural Resources Ltd. (CNQ-T, “buy”) to $97 from $105. Average: $95.47.
- Cenovus Energy Inc. (CVE-T, “buy”) to $27.50 from $34. Average: $29.63.
- Imperial Oil Ltd. (IMO-T, “hold”) to $77 from $82. Average: $84.75.
- Suncor Energy Inc. (SU-T, “hold”) to $45 from $49. Average: $51.
- Tourmaline Oil Corp. (TOU-T, “buy”) to $76 from $85. Average: $79.53.
“From a valuation perspective, the recent softness in commodity prices has contributed to sluggish equity performance, holding valuations in line with historical levels, although we still believe that the sector offers attractive opportunities for value-focused investors to selectively deploy capital.” he said. “On that note, FCF yields within the Desjardins E&P coverage universe have moderated to the 9–10-per-cent level on average at current strip prices, although we note that 2024 FCF has effectively dried up among small-cap natural gas–weighted producers. However, capital return yields remain attractive, averaging 6 per cent in 2024 at current strip prices, and are expected to accelerate to 7 per cent in 2025 as additional corporate net debt targets are achieved.
“Going forward, we retain our near-term bias toward oil-weighted producers, where we see greater FCF resiliency with TMX coming online later this year. We continue to highlight CVE as our top pick in the large-cap integrated oil space following significant underperformance through the opening weeks of 2024, with the stock trading down 9.1 per cent to date this year (vs peers at down 1.2 per cent). While acknowledging that the market is reacting to disappointing upstream production and sliding crack spreads, the latter of which appears to have removed the potential for meaningful 4Q23 downstream cash flow contribution, we also believe that it is failing to recognize the potential impact of narrowing WTI–WCS differentials when TMX begins linefill.”
Mr. MacCulloch’s other top picks are:
Mid-cap oil: Enerplus Corp. (ERF-T, “buy”) with a $20 target, down from $23. Average: $20.80.
“We believe it offers one of the best value propositions in the Canadian energy sector, currently trading at 3.0 times 2025 DACF [debt-adjusted cash flow] multiple (vs peers at 4.0 times) while providing a 12.2-per-cent FCF yield at strip prices,” he said. “We also believe the company could be a beneficiary of booming U.S. M&A activity, either as a consolidator within North Dakota or as a potential target.”
Small-cap oil: Headwater Exploration Inc. (HWX-T, “buy”) with a $8.75 target, down from $10. Average: $9.18.
“We highlight HWX as our top pick in the small-cap oil space given our constructive outlook for WCS prices and the company’s ability to add short-cycle barrels, which we expect to be augmented by its new Clearwater lookalike plays — we expect further details in the not-too-distant future,” he said. “We also note that HWX retains considerable financial dry powder to add scale through M&A given its pristine balance sheet and more than $100-million of cash.”
Large-cap natural gas: Arc Resources Ltd. (ARX-T, “buy”) with a $29 target, down from $31. Average: $26.70.
“We continue to highlight ARX as our favourite large-cap natural gas name given its pristine balance sheet, strong growth visibility from Attachie and advantaged position as the leading condensate producer in the basin, with TMX linefill expected to drive increased diluent demand,” he said.
Small/mid-cap natural gas: Advantage Energy Ltd. (AAV-T, “buy”) with a $13 target, down from $13.25. Average: $12.51.
“Our top pick in the small/mid-cap natural gas space is AAV, which offers 14-per-cent PPS growth, augmented by share repurchases with 100 per cent of FCF currently allocated to buybacks. We also anticipate a meaningful acceleration in CCS developments this year for Entropy in the U.S. and Canada, the latter of which will be backstopped by the recent partnership with the Canada Growth Fund.,” he said.
Royalty: Topaz Energy Corp. (TPZ-T, “buy”) with a $26.50 target, down from $27.50. Average: $27.04.
“We believe the company is well-positioned to capitalize on our expectation for a more robust Canadian M&A market while retaining strong organic growth visibility from its extensive holdings in the Montney and Clearwater plays. Despite near-term natural gas price weakness, we believe the dividend is wellprotected by the stable cash flow stream provided by the infrastructure assets,” he said.