The novel coronavirus outbreak has created a challenging environment for the Zacks Oil and Gas - Exploration and Production - Canadian industry. The unprecedented steps to contain the pandemic have wreaked havoc on energy demand.
Despite signs of tightening fundamentals, Canadian crude prices are most likely to trade at a discount to their U.S. benchmark because of quality and pipeline issues. Nevertheless, industry players like Canadian Natural Resources Limited (CNQ - Free Report) , Ovintiv Inc. (OVV - Free Report) , Enerplus Corporation (ERF - Free Report) and Gran Tierra Energy Inc. (GTE - Free Report) are expected to benefit from the uptick in commodity prices.
About the Industry
The Zacks Oil and Gas - Canadian E&P industry consists of Canada-based companies focused on exploration and production (E&P) of oil and natural gas. These firms are engaged in finding hydrocarbon reservoirs, drilling oil and gas wells, and producing and selling these materials to be refined later into products such as gasoline.
3 Key Investing Trends to Watch in the Oil and Gas - Canadian E&P Industry
Dearth of Pipeline Capacity: While oil production is surging in Canada, the country's exploration and production sector has remained out of favor, primarily due to the scarcity of pipelines. In short, pipeline construction in Canada has failed to keep pace with rising domestic crude volumes — the heavier sour variety churned out of the oil sands — resulting in infrastructural bottleneck. This has forced producers to give away their products in the United States — Canada’s major market — at a discounted rate. As it is, Canadian heavy crude is inferior to the higher-quality oil extracted from shale formations in the United States and is more expensive to transport and refine.
Improved Pricing Backdrop: Oil has clawed back some of the ground lost in a sharp selloff associated with the coronavirus-induced demand destruction for the fuel. Likewise, Western Canadian Select has remained essentially stable over the past few months, with the benchmark price for Alberta oil sands back at around $35 a barrel. The contract’s steady uptick is an indication of a tighter market as easing lockdown measures improve the demand outlook amid massive production cuts by the OPEC+ group. Adding to the supply reductions, top Canadian and U.S. producers have all slashed production. Meanwhile, natural gas fundamentals are also expected to improve on lower associated output tied to the brake in shale oil production. In fact, the EIA forecasts an average price of $3.13 per MMBtu over the course of 2021, up significantly from this year’s projection of $2.07 per MMBtu.
Lingering Signs of Demand Weakness: The impressive rally notwithstanding, oil prices are unlikely to move much higher as commercial passenger flights remain curtailed. In particular, the usage of distillates such as aviation fuel remains weak with air travel essentially grounded. As long as the coronavirus outbreak continues (as is now the case in India and a second wave across Europe), there will be pressure on the demand side of the equation. Per the International Energy Agency, the degree of recovery in oil consumption is expected to decelerate through the remainder of this year driven by localized lockdowns and containment measures to tackle the recent increase in COVID-19 cases.
Zacks Industry Rank Indicates a Murky Outlook
The Zacks Oil and Gas - Canadian E&P is a 6-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #231, which places it in the bottom 9% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bearish near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Despite the bleak near-term prospects of the industry, we will present a few stocks that you may want to consider for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.
Industry Mixed on Stock Market Performance
The Zacks Oil and Gas - Canadian E&P fared better than the broader Zacks Oil - Energy Sector but has lagged the Zacks S&P 500 composite over the past year.
The industry has lost 37.2% over this period compared to the S&P 500’s rally of 17.4% and broader sector’s decrease of 39.9%.
One-Year Price Performance
Industry’s Current Valuation
Since oil and gas companies are debt-laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of noncash expenses.
On the basis of the trailing 12-month EV/EBITDA ratio, the industry is currently trading at 3.91X, significantly lower than the S&P 500’s 15.24X. It is also below the sector’s trailing-12-month EV/EBITDA of 4.05X.
Over the past five years, the industry has traded as high as 17.93X, as low as 2.72X, with a median of 6.89X, as the chart below shows.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio
4 Oil and Gas - Canadian E&P Stocks to Focus on Amid Pandemic-Led Headwinds
Canadian Natural Resources: This Canadian energy major currently carries a Zacks Rank #3 (Hold). The company boasts a diversified portfolio of crude oil (heavy as well as light), natural gas, bitumen and synthetic crude oil. Canadian Natural Resources has decided to maintain its dividend despite the sudden drop in oil price, reflecting strength in its cash flows. The company is counted as a Canadian Dividend Aristocrat with an attractive yield.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Over the past 60 days, Canadian Natural Resources has seen the Zacks Consensus Estimate for 2020 improve 18.1%. The stock has gained 36.3% over the past six months.
Price and Consensus: CNQ
Ovintiv: An upstream operator, Ovintiv (formerly known as Encana), holds principal assets in the Anadarko Basin, located in the western and central parts of Oklahoma; the Permian Basin located in the western Texas and south eastern New Mexico, the Midland Basin in Texas and the Montney Basin in western Canada. The company’s cost-saving initiatives remain on track with the excess cash flow set to go toward lowering of debt over the next six quarters.
Over the past 60 days, this #3 Ranked company has seen the Zacks Consensus Estimate for 2020 improve 8.3%. The stock has surged 115.3% over the past six months.
Enerplus Corporation: Enerplus focuses on Bakken and Three Forks formations in the Williston Basin in North Dakota, together with interests in the Marcellus Basin in and waterflood projects in Canada. Banking on its low financial leverage and robust liquidity, this upstream energy firm, carrying a Zacks Rank #3, is in a relatively better position to tackle the coronavirus-led industry woes.
Over the past 60 days, this Calgary, Alberta-based company has seen the Zacks Consensus Estimate for 2020 improve 71.4%. The stock has edged down 0.5% over the past six months.
Price and Consensus: ERF
Gran Tierra Energy: Gran Tierra Energy focuses on oil and natural gas exploration and production in Colombia and Ecuador. The company’s strategy is to target any large prospective acreage spread over proven plays. Grant Tierra Energy’s low cost structure places it at an advantage to withstand the weak commodity prices.
The 2021 Zacks Consensus Estimate for this Canada-based company indicates 80.2% earnings per share growth over 2020. The #3 Ranked stock has lost 28.8% over the past six months.
Price and Consensus: GTE