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3 Stocks to Play the Canadian E&P Industry Upcycle
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After suffering a frightening crash in 2020, the Zacks Oil and Gas - Exploration and Production - Canadian industry has been uphill since the start of this year, thanks to surging demand from the economic reopening. As oil and natural gas prices in Canada continue to move higher, upstream firms like Ovintiv (OVV - Free Report) , Crescent Point Energy (CPG - Free Report) and Baytex Energy are likely to see impressive revenue and cash flow growth.
About the Industry
The Zacks Oil and Gas - Canadian E&P industry consists of companies primarily based in Canada, focused on the exploration and production (E&P) of oil and natural gas. These firms find hydrocarbon reservoirs, drill oil and gas wells, and produce and sell these materials to be refined later into products such as gasoline, fuel oil, distillate, etc. The economics of oil and gas supply and demand is the fundamental driver of this industry. In particular, a producer’s cash flow is primarily determined by the realized commodity prices. In fact, all E&P companies' results are vulnerable to historically volatile prices in the energy markets. A change in realizations affects their returns and causes them to alter their production growth rates. The E&P operators are also exposed to exploration risks where drilling results are comparatively uncertain.
3 Key Investing Trends to Watch in the Oil and Gas - Canadian E&P Industry
Constructive Fundamentals Push Commodity Prices Higher: Energy recovery is gaining steam at a faster-than-expected pace as investors welcome the reality of a post-vaccine world. Mobility restrictions have been rolled back and most parts of the economy have reopened. Adding to this bullish narrative are the OPEC+ production cut and supportive government policies. Consequently, the demand for oil and gas is flourishing. With WCS crude — the Canadian benchmark — recently rallying toward C$70-a-barrel and natural gas surging to 13-year highs amid the macro tailwinds, the E&P companies will greatly benefit for obvious reasons. Importantly, commodity prices appear to have entered a protracted period of stability at levels where the operators can generate free cash flow through their drilling activities.
Sustainable Cost Savings: Canadian energy companies have changed their approach to spending capital. Over the past few years, producers worked tirelessly to cut costs to a bare minimum and look for innovative ways to churn out more oil and gas. They managed to do just that by 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 constrain short-term production but are expected to preserve cash flow, support balance sheet strength and help the companies eventually emerge stronger. In particular, cash from operations is on a sustainable path as revenues improve and companies slash capital expenditures from the pre-pandemic levels amid sharply higher commodity prices.
Lack of Pipeline Capacity Restricts Canadian Oil Industry: Energy consultant IHS Markit sees oil production in Canada surging by some 900,000 barrels per day during the 2020-2030 period. Despite this impressive output growth, 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 an 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 - Free Report) contentious Keystone XL pipeline and the company’s subsequent termination of the project, 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 five-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #17, which places it in the top 7% 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 are highly optimistic about this group’s earnings growth potential. While the industry’s earnings estimates for 2021 have surged 2,650% in the past one year, the same for 2022 have soared 3,216.7% over the same timeframe.
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 rocketed 136.2% over this period compared with the broader sector’s increase of 60.1%. Meanwhile, the S&P 500 has gained 35.6%.
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 non-cash expenses.
On the basis of the trailing 12-month EV/EBITDA ratio, the industry is currently trading at 6.41X, significantly lower than the S&P 500’s 15.66X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 4.98X.
Over the past five years, the industry has traded as high as 18.68X, as low as 2.79X, with a median of 6.85X, as the chart below shows.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
Stocks to Watch Out For
Ovintiv: An upstream operator, Ovintiv (formerly known as Encana) holds attractive oil and gas production portfolio in three major North American unconventional basins: Montney, Anadarko and the Permian. Following the Newfield acquisition in 2019, the company has achieved higher liquids focus, greater scale and cost synergies. Ovintiv has also done a commendable job of cutting its expenses in a disciplined manner, which should boost free cash flow generation.
The 2021 Zacks Consensus Estimate for Ovintiv indicates 1,442.9% earnings per share growth over 2020. The company currently carries a Zacks Rank #1 (Strong Buy), while its shares have gained 161.9% year to date.
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 ShellA) Alberta assets for C$900 million, counts operational excellence and prudent cost management as its strength.
The 2021 Zacks Consensus Estimate for the company indicates 1,260% earnings per share growth over 2020. Crescent Point stock is up 106.5% so far this year.
Price and Consensus: CPG
Baytex Energy: An energy producer based in Western Canada, Baytex focuses on high quality and diversified oil portfolio across multiple plays spanning across Peace River, Duvernay, Lloydminster and Viking. The company is also active in the Eagle Ford shale. Banking on its strong execution and disciplined capital allocation, Baytex is on track to generate substantial free cash flow in this commodity upcycle. The company is also relentlessly working to improve its leverage ratios and enhance shareholder returns.
The 2021 Zacks Consensus Estimate for Baytex indicates 538.9% earnings per share growth over 2020. The company, carrying a Zacks Rank of 2, has seen its stock go up 15.4% in 2021.
Price and Consensus: BTEGF
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3 Stocks to Play the Canadian E&P Industry Upcycle
After suffering a frightening crash in 2020, the Zacks Oil and Gas - Exploration and Production - Canadian industry has been uphill since the start of this year, thanks to surging demand from the economic reopening. As oil and natural gas prices in Canada continue to move higher, upstream firms like Ovintiv (OVV - Free Report) , Crescent Point Energy (CPG - Free Report) and Baytex Energy are likely to see impressive revenue and cash flow growth.
About the Industry
The Zacks Oil and Gas - Canadian E&P industry consists of companies primarily based in Canada, focused on the exploration and production (E&P) of oil and natural gas. These firms find hydrocarbon reservoirs, drill oil and gas wells, and produce and sell these materials to be refined later into products such as gasoline, fuel oil, distillate, etc. The economics of oil and gas supply and demand is the fundamental driver of this industry. In particular, a producer’s cash flow is primarily determined by the realized commodity prices. In fact, all E&P companies' results are vulnerable to historically volatile prices in the energy markets. A change in realizations affects their returns and causes them to alter their production growth rates. The E&P operators are also exposed to exploration risks where drilling results are comparatively uncertain.
3 Key Investing Trends to Watch in the Oil and Gas - Canadian E&P Industry
Constructive Fundamentals Push Commodity Prices Higher: Energy recovery is gaining steam at a faster-than-expected pace as investors welcome the reality of a post-vaccine world. Mobility restrictions have been rolled back and most parts of the economy have reopened. Adding to this bullish narrative are the OPEC+ production cut and supportive government policies. Consequently, the demand for oil and gas is flourishing. With WCS crude — the Canadian benchmark — recently rallying toward C$70-a-barrel and natural gas surging to 13-year highs amid the macro tailwinds, the E&P companies will greatly benefit for obvious reasons. Importantly, commodity prices appear to have entered a protracted period of stability at levels where the operators can generate free cash flow through their drilling activities.
Sustainable Cost Savings: Canadian energy companies have changed their approach to spending capital. Over the past few years, producers worked tirelessly to cut costs to a bare minimum and look for innovative ways to churn out more oil and gas. They managed to do just that by 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 constrain short-term production but are expected to preserve cash flow, support balance sheet strength and help the companies eventually emerge stronger. In particular, cash from operations is on a sustainable path as revenues improve and companies slash capital expenditures from the pre-pandemic levels amid sharply higher commodity prices.
Lack of Pipeline Capacity Restricts Canadian Oil Industry: Energy consultant IHS Markit sees oil production in Canada surging by some 900,000 barrels per day during the 2020-2030 period. Despite this impressive output growth, 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 an 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 - Free Report) contentious Keystone XL pipeline and the company’s subsequent termination of the project, 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 five-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #17, which places it in the top 7% 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 are highly optimistic about this group’s earnings growth potential. While the industry’s earnings estimates for 2021 have surged 2,650% in the past one year, the same for 2022 have soared 3,216.7% over the same timeframe.
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 rocketed 136.2% over this period compared with the broader sector’s increase of 60.1%. Meanwhile, the S&P 500 has gained 35.6%.
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 non-cash expenses.
On the basis of the trailing 12-month EV/EBITDA ratio, the industry is currently trading at 6.41X, significantly lower than the S&P 500’s 15.66X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 4.98X.
Over the past five years, the industry has traded as high as 18.68X, as low as 2.79X, with a median of 6.85X, as the chart below shows.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
Stocks to Watch Out For
Ovintiv: An upstream operator, Ovintiv (formerly known as Encana) holds attractive oil and gas production portfolio in three major North American unconventional basins: Montney, Anadarko and the Permian. Following the Newfield acquisition in 2019, the company has achieved higher liquids focus, greater scale and cost synergies. Ovintiv has also done a commendable job of cutting its expenses in a disciplined manner, which should boost free cash flow generation.
The 2021 Zacks Consensus Estimate for Ovintiv indicates 1,442.9% earnings per share growth over 2020. The company currently carries a Zacks Rank #1 (Strong Buy), while its shares have gained 161.9% year to date.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Price and Consensus: OVV
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 ShellA) Alberta assets for C$900 million, counts operational excellence and prudent cost management as its strength.
The 2021 Zacks Consensus Estimate for the company indicates 1,260% earnings per share growth over 2020. Crescent Point stock is up 106.5% so far this year.
Price and Consensus: CPG
Baytex Energy: An energy producer based in Western Canada, Baytex focuses on high quality and diversified oil portfolio across multiple plays spanning across Peace River, Duvernay, Lloydminster and Viking. The company is also active in the Eagle Ford shale. Banking on its strong execution and disciplined capital allocation, Baytex is on track to generate substantial free cash flow in this commodity upcycle. The company is also relentlessly working to improve its leverage ratios and enhance shareholder returns.
The 2021 Zacks Consensus Estimate for Baytex indicates 538.9% earnings per share growth over 2020. The company, carrying a Zacks Rank of 2, has seen its stock go up 15.4% in 2021.
Price and Consensus: BTEGF