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Canadian E&P Industry is Back on Track: 4 Stocks in Focus

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After an extremely challenging 2020, the Zacks Oil and Gas - Exploration and Production - Canadian industry is looking up with regional oil and gas prices soaring to multi-year highs.

The improvement in commodity realizations is expected to increase returns for exploration and production (E&P) or upstream firms like Canadian Natural Resources (CNQ - Free Report) , Ovintiv (OVV - Free Report) , Crescent Point Energy (CPG - Free Report) and Enerplus Corporation (ERF - Free Report) .

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

Recovery in Canadian Crude Prices: The price of WCS crude — the Canadian benchmark — has come a long way since the depths of negative prices in April. Currently at a 22-month high of nearly $50 a barrel, the oil market is expected to tighten throughout 2021, supported by the OPEC+ cuts, easing of the lockdown and an earlier-than-expected pickup in the commodity’s demand on the back of vaccine rollouts. Adding to these positive indicators, top Canadian and U.S. producers have all slashed production. Meanwhile, Canada’s AECO natural gas prices recently jumped to a seven-year high as the winter cold and snow storms resulted in strong demand on the back of a ramp up in the use of heaters. The oil and gas price gains will greatly benefit the results of E&P companies for obvious reasons.

Continued Focus on Cost Reduction Opportunities: The energy companies have changed their approach to spending capital. Over the past few years, producers have worked tirelessly to cut costs to a bare minimum and look for innovative ways to churn out more oil and gas. They have managed to do just that by leveraging technology, improving drilling techniques and extracting favorable terms from the beleaguered service providers. Moreover, driven by operational efficiencies, most E&P operators have been able to reduce unit costs, while the coronavirus-induced collapse in crude has forced them to adopt a more disciplined approach to spending capital. These actions might decrease short-term production but are expected to preserve cash flow, support balance sheet strength and help the companies emerge stronger eventually. Most firms’ capital spending in 2020 was substantially lower than 2019 and also less than their initial estimates. The focus in 2021 will on sustaining the lower spending levels, further trimming breakeven costs and maintaining financial health.

Oil Producers Starved for Pipelines: 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. Following U.S. President Joe Biden’s revocation of TC Energy’s TRP contentious Keystone XL pipeline, Canadian oil sands producers will have to wait a little longer for the takeaway capacity issue to be resolved.

Zacks Industry Rank Indicates Positive Outlook

The Zacks Oil and Gas - Canadian E&P is a four-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #19, which places it in the top 8% 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 bright 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.

The industry’s position in the top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts foresee an optimistic scenario about this group’s earnings growth potential. As a proof of this, the industry’s earnings estimates for 2021 have more than quadrupled in five months.

Considering the encouraging 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 Outperforms Sector & S&P 500

The Zacks Oil and Gas - Canadian E&P has fared better than the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.

The industry has improved 30.6% over this period against the broader sector’s decrease of 7.4%. Meanwhile, the S&P 500 has gained 22.2%.

 

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 non-cash expenses.

On the basis of the trailing 12-month EV/EBITDA ratio, the industry is currently trading at 7.19X, significantly lower than the S&P 500’s 16.64X. It is, however, above the sector’s trailing-12-month EV/EBITDA of 5.34X.

Over the past five years, the industry has traded as high as 17.93X, as low as 2.72X, with a median of 6.65X, as the chart below shows.

 

 

Stocks to Watch Out For

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 few quarters.  

The 2021 Zacks Consensus Estimate for Ovintiv indicates 448.57% earnings per share growth over 2020. The company currently carries a Zacks Rank #1 (Strong Buy).

You can see the complete list of today’s Zacks #1 Rank stocks here.

 

Crescent Point Energy: This Calgary-based company, whose operations are primarily concentrated in southwest and southeast Saskatchewan, carries a Zacks Rank #2 (Buy). Crescent Point, which recently acquired Royal Dutch Shell’s RDS.A Alberta assets for C$900 million, counts operational excellence and prudent cost management as its strength.

Over the trailing four quarters, the company surpassed the Zacks Consensus Estimate on three occasions and matched the same in the other, the surprise being 268.75%, on average.

 

Canadian Natural Resources: This Canadian energy major 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 last year’s historical drop in oil price, reflecting strength in its cash flows. The company is counted as a Canadian Dividend Aristocrat with an attractive yield.

The 2021 Zacks Consensus Estimate for Canadian Natural Resources indicates 239.15% earnings per share growth over 2020. The company currently carries a Zacks Rank #3 (Hold).

 

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 is in a relatively better position to tackle the coronavirus-led industry woes.

The 2021 Zacks Consensus Estimate for Enerplus indicates 1,314.29% earnings per share growth over 2020. The company currently carries a Zacks Rank #3.

 

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