A major tailwind in the form of high oil and natural gas prices is likely to position the Zacks
Oil and Gas - Exploration and Production - Canadian industry for substantial gains for the remainder of this year. Building on this bullish narrative, there is significant upside in upstream firms like Canadian Natural Resources ( CNQ Quick Quote CNQ - Free Report) , Ovintiv ( OVV Quick Quote OVV - Free Report) , Crescent Point Energy ( CPG Quick Quote CPG - Free Report) and Enerplus ( ERF Quick Quote ERF - Free Report) . With an all-round improvement in efficiency and cost structure, these companies should experience impressive revenue and cash flow growth. About the Industry
The Zacks Oil and Gas - US E&P industry consists of companies primarily based in the domestic market, 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
Earlier this year, the price of WCS crude — the Canadian benchmark — rose above $100 a barrel to reach its highest since 2008 on account of Russia’s launch of military operations in Ukraine. Agreed, crude has pulled back from those lofty levels on inflation and economic slowdown concerns, but with the conflict showing no signs of a quick resolution and the European Union following the United States in blocking imports of Russian energy, global supply remains strained amid resilient demand. What’s more, the commodity could spike further if the United States decides to tap Canada to replace its imports from Moscow that has been banned by the Biden administration. With even natural gas realizations remaining healthy amid the macro tailwinds, the E&P companies will greatly benefit for obvious reasons. Encouraging Fundamentals Driving Commodity Prices: 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. And 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-triggered destruction in crude 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 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. Positive Impacts of Aggressive Cost Reductions: 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 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. Takeaway Constraints Plague Producers: Zacks Industry Rank Indicates Positive Outlook
The Zacks Oil and Gas - Canadian E&P is a seven-stock group within the broader Zacks
Oil - Energy sector. The industry currently carries a Zacks Industry Rank #70, which places it in the top 28% 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 2022 have surged 130.5% in the past year, the same for 2023 have soared 143.9% 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 55.7% over this period compared with the broader sector’s increase of 24.7%. Meanwhile, the S&P 500 has lost 9.9%. 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 non-cash expenses.
On the basis of the trailing 12-month EV/EBITDA ratio, the industry is currently trading at 3.98X, significantly lower than the S&P 500’s 12.36X. It is, however, above the sector’s trailing-12-month EV/EBITDA of 3.63X. Over the past five years, the industry has traded as high as 12.42X, as low as 2.79X, with a median of 5.52X, as the chart below shows. Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
Stocks to Watch For
Enerplus: An upstream operator, Enerplus focuses on Bakken and Three Forks formations in the Williston Basin in North Dakota, together with interests in the Marcellus Basin and waterflood projects in Canada. Banking on its low financial leverage and robust liquidity, ERF is in a pole position to take advantage of the sharply higher commodity prices. Over 60 days, Enerplus has seen the Zacks Consensus Estimate for 2022 increase 18.6%. Sporting a market capitalization of around $2.8 billion, the Zacks Rank #1 (Strong Buy) ERF’s shares have gained some 107.6% in a year. Price and Consensus: ERF
Canadian Natural Resources: This Calgary-based energy major boasts a diversified portfolio of crude oil (heavy as well as light), natural gas, bitumen and synthetic crude oil. CNQ’s balanced and diverse production mix facilitates long-term value and reduces the risk profile, thereby lending its results a high level of stability. Lower capital expenditure needs, accretive acquisitions and improving operational efficiencies are the other positives in the Canadian Natural story, which allowed the company to generate a significant free cash flow of C$8 billion (post capital spending and dividends) in 2021. Notably, CNQ beat the Zacks Consensus Estimate for earnings in each of the last four quarters. The company has a trailing four-quarter earnings surprise of roughly 17.6%, on average. Canadian Natural, with a Zacks Rank #3 (Hold), has seen its shares gain around 54% in a year. Price and Consensus: CNQ
Crescent Point Energy: This Calgary-based company, whose operations are primarily concentrated in southwest and southeast Saskatchewan, carries a Zacks Rank of 3. Crescent Point, which acquired Shell’s Alberta assets for C$900 million last year, counts operational excellence and prudent cost management as its strength. With a low-risk drilling inventory of long-life assets and strong market access, CPG is also making progress on balance sheet strength and shareholder return initiatives. Over 60 days, Crescent Point has seen the Zacks Consensus Estimate for 2022 increase 73.7%. Valued at around $3.8 billion, CPG has a projected earnings growth rate of 276.4% for this year. Crescent Point’s shares have gained some 109.1% in a year. Price and Consensus: CPG
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. Headquartered in Denver, CO, Ovintiv has a projected earnings growth rate of 87.6% for this year. OVV’s expected EPS growth rate for three to five years is currently 37.7%, which compares favorably with the industry's growth rate of 28.3%. Ovintiv, a Zacks Rank #3 stock, has seen its shares go up 66.1% in a year. Price and Consensus: OVV