Canadian gas-weighted stocks experienced a modest rally in late April, with high quality, larger capitalization names posting best-in-class returns over a two-week period, writes Canaccord Wealth Management in its Morning Coffee newsletter.
On average, gas stocks gained about 20% through late April/early May; however, they have given back more than half of their gains over the past two weeks, supporting Canaccord Genuity’s view that the equity rally may have been somewhat premature.
Although Canaccord Genuity’s Energy Team remain constructive on natural gas over the longer term, they highlight six reasons that lead them to believe a sustained gas stock rally may be several months away and that equities could trade relatively flat through the summer:
- Gas-weighted stocks are ahead of themselves from a valuation perspective, discounting US$4.10 gas prices. Stocks are forward looking, however the Team doesn’t see a monthly gas contract above US$4.10/Mcf on the current forward strip until December 2014. In the near-term, forward strip could remain flat through the summer as producers ride out 2012 hedges and look to layer on 2013 natural gas protection at prices in the mid C$3/Mcf range;
- U.S. natural gas storage could reach theoretical capacity later this summer. Currently, U.S. storage is at its highest level in the past seven years and at the end of March storage was 60% above its five-year average;
- Modest capital cuts and shut-in volumes haven’t moved the supply needle in our coverage universe for domestic producers;
- Banks were generally supportive in their spring 2012 reviews, which will likely promote continued drilling activity. To date only a handful of gas-weighted stocks announced a credit facility decrease;
- Lack of M&A activity suggests industry may have not seen the bottom yet;
- Reserve risk for some gas-weighted producers is not appropriately priced into the stocks.
The Team suggests that investors be wary of the headfake and remain focused on high quality gas names such as Celtic Exploraton Ltd. (TSX: T.CLT, Stock Forum), Peyto Exploraton & Development Corp. (TSX: V.PEY, Stock Forum)and Progress Energy Resources Corp. (TSX: V.PRQ, Stock Forum)and buy on dips through the summer in advance of a sector rally.
They believe gas-weighted stocks such as Birchcliff Energy Ltd. (TSX: T.BIR, Stock Forum), Fairborne Energy Ltd. (TSX: T.FEL, Stock Forum), Cequence Energy Ltd. (TSX: T.CQE, Stock Forum)and Nuvista Energy Ltd. (TSX: T.NVA, Stock Forum)could see weakness relative to the “go to” gas names through this summer.