MARKET OUTLOOK:

The one-month selloff in oil has been violent, with fears of a potentially vaccine resistant Omicron combined with confusion around the significance of a strategic petroleum reserve release resulting in a US$17/bbl plunge. 

With the oil price implosion implying a 7M bbl/day collapse in demand for an entire quarter (equivalent to 50 per cent of the demand destruction from the global lockdown in April 2020) I believe the likely worst-case scenario from Omicron has been totally baked in allowing for a meaningful relief rally if positive news around vaccine efficacy comes out in the next few weeks. 

We remain in a multi-year bull market for oil and I would be aggressively using this pullback to add.  Energy stocks are trading at 2.8x enterprise value to cash flow and a 26 per cent free cash flow yield at US$70 WTI, an oil price level I expect the market to return to by early 2022.
 
TOP PICKS:

Baytex Energy (BTE TSX)
Last bought on December 1st at $3.74
Baytex will have free cash flow more than their market capitalization over the next five years at US$65 WTI and trades at 2.8x EV/CF and a 28 per cent free cash flow yield at US$70 WTI. Having drilled the two best wells in the Clearwater play, the most economic oil play in North America, Baytex’s asset quality is misunderstood as people still think of it as an overleveraged heavy oil producer. We think fair value is close to $5.75/share at US$70 WTI and $7.35 at US$80 WTI, representing 61 per cent/109 per cent potential upside.

Headwater Exploration (HWX TSX)
Last bought on December 1st at $4.50 
Headwater offers pure play exposure to the most economic oil play in North America while being led by a proven value creator with a debt free balance sheet. Recent waterflood success and exploration success only add to the attractiveness of the story and with the stock trading at 2.8x 2023 EV/CF at US$70 WTI, we think the stock offers meaningful upside.

Enerplus (ERF TSX)
Last bought on November 30th at $12.17 
Enerplus trades at a pathetically low multiple of 2.5x EV/CF at US$70 WTI despite having at least 10 years of stay-flat inventory in their core Bakken play. Trading at a 25 per cent free cash flow yield and a sub 0.5x debt to cash flow multiple