Q2/22 Preview
Fundamentals Improving Despite Commodity Pullback See Meaningful Value in Select Opportunities
TD Investment Conclusion
Commodity Price Deck and Industry Forecast Update: We are updating our commodity price deck and industry forecasts for Q2/22 actuals and our updated sector outlook. Specifically, our near- and medium-term crude-oil and natural-gas commodity price outlook improves, while our long-term estimates remain relatively flat. In general, our price deck remains well below prevailing strip prices. In light of our improving commodity price outlook, we are also increasing our Canadian and U.S. activity forecasts with this report. Details on page 4.
Q2/22 Preview & Estimate Changes: Canadian Drilling & Completions (D&C) activity significantly outperformed our expectations due to a combination of constructive ground conditions and a clear willingness among E&Ps to use what is typically the seasonally slowest quarter to get ahead of further service cost inflation. U.S. activity levels continued to trend higher and we have improved visibility toward continued upward momentum based on conversations that we have had with our coverage universe. With a few exceptions related to inflationary pressure or company-specific issues, our Q2/22, 2022, and 2023 estimates generally increase with this update. However, we have also contemplated higher discount rates in our NAV calculations to reflect recent share-price volatility. As a result, target prices and ratings across our coverage universe remain unchanged.
Our Sector Stance: OVERWEIGHT
In our Q1/22 preview (full report), we highlighted that the OSX index and WTI had featured a very strong correlation year-to-date, and highlighted that any weakness in WTI would have a direct impact on sector share-price performance. Not only did this play out, but also stocks significantly underperformed the commodity price over the past month. In our view, prevailing valuations at recent share-price highs were implying significant D&C activity growth and margin expansion expectations into 2023, something we have increasing visibility toward, but that left very little incremental upside for the marginal investor. The recent underperformance in equities relative to the commodity creates an entry point, in our view, and we see the pullback as a potential buying opportunity. However, we also note that there are several companies in our coverage universe that did not participate in the energy rally earlier this year, but traded down over the past month with the reduction in commodity prices. As a result, we see meaningful value in select names at current valuations. Specifically, we highlight CES Energy Solutions Corp. (CEU-T, BUY, $5.00 target price), Enerflex (EFX-T, BUY, $16.00 targetprice), North American Construction Group (NOA-T, BUY, $25.00 targetprice), and Shawcor (SCL-T, BUY, $7.50 targetprice) as our best ideas in the space (see page 3 for more details).