Eric Nuttall's Top Picks: Dec. 11, 2020

Eric Nuttall, partner and senior portfolio manager at Ninepoint Partners
Focus: Energy stocks

MARKET OUTLOOK

Oil has entered into a multi-year bull market. Already, countries including China, India and Brazil are back to pre-COVID demand levels while other regions more affected like the U.S. and Europe are imminently rolling out numerous vaccines. We can now look through to a post-COVID world in 2021, but what does that look like for energy investors?

Prior to COVID, certain bullish trends were already in place and have now been accelerated: loss of U.S. shale production growth due to a need to prioritize return of capital over drillbit spending, a global offshore plateau/decline due to over five years of insufficient investment in new projects and limited OPEC spare capacity (adjusting for curtailed production that will be brought online in 2021 as demand continues to normalize). The global oil inventory surplus has already fallen by about 33 per cent from its high and we see normalized oil inventory levels by the 2H/21. While much of the market’s focus remains on the temporary COVID-induced demand destruction such as business jet travel (1.4 million barrels per day out of a pre-COVID demand of 102 million bbl/d) energy investors should be focusing on the structural impact on supply as that will be much longer lasting. The era of U.S. shale growth is largely over, global offshore production will struggle to grow for the next four years and OPEC by the end of 2021 will have very limited spare capacity.

The oil price was at $62 before COVID struck. We see a tighter supply/demand reality in 2021 than the beginning of this year, so why can’t oil get back to $60? For a more thorough, discussion listen to my presentation here.

With that backdrop, despite the 50 per cent rally in energy stocks over the past month if one believes in $50 oil, many energy stocks are still at least doubles and at $60 they offer multi-bagger status. If you do not have a full weight towards the sector, there is no reason not to add exposure now.

TOP PICKS

Whitecap Resources (WCP TSX)

With their acquisitions of NAL Resources and TORC, Whitecap has become the “must-own” midcap oil stock in Canada and is my fund’s largest holding. While the stock now trades at a premium to the group (5.6/4 times at $50/$60 proforma), they are in the clear position to be the consolidator of choice moving forward. With a free cashflow yield of 13/25 per cent ($50/$60), I still think the stock is a double from current levels in the 2H/21 when oil approaches $60.

Canadian Natural Resources (CNQ TSX)

The Canadian large caps have lagged the move in the small caps and offer tremendous value. Canadian Natural, Suncor and Cenovus each represent 10 per cent of my fund currently. CNQ trades at a 13/18 per cent free cashflow yield at $50/$60 and is still down 24 per cent on the year. With a post-dividend break (current yield is 5.3 per cent) even of only $38 per barrel, CNQ will be a free cashflow machine under our oil price forecast ($50 in H1/21 and $60 in 2H/21) and possesses what every energy investor in the world will look for: low decline (10 per cent), long reserve life, and a focus on free cash flow. CNQ could double over the next year.

Tamarack Valley (TVE TSX)

The TORC-Whitecap merger has shattered the status quo: small cap companies must get bigger in order to gain relevance with large institutional investors or they need to exit. It is that simple. We see Tamarack Velley as the next most likely takeout candidate in Canada. It trades inexpensively (3.5/2.6 times at $50/$60 WTI), has a low level of debt (1.50 times at $50), a low decline rate given its successful waterflood project (23 per cent) and can generate a tremendous amount of free cashflow (13/32 per cent free cashflow yield at $50/$60). The stock is still down 40 per cent year-to-date and we see over 100 per cent upside if we are correct that oil will rally to $60 WTI in 2H/21.

PAST PICKS: DEC. 19, 2019

Baytex Energy (BTE TSX)

•  Then: $1.73
•  Now: $0.83
•  Return: -52%
•  Total Return: -52%

Crescent Point Energy (CPG TSX)

•  Then: $5.51
•  Now: $3.06
•  Return: -45%
•  Total Return: -44%

Tourmaline Oil (TOU TSX)

•  Then: $15.06
•  Now: $17.31
•  Return: +15%
•  Total Return: +17%

Total Return Average: -26%

Twitter: @ericnuttall
Website: www.ninepoint.com