Yahoo Finance 3 Stocks in the Canadian Upstream Industry Worth Some Thought
The Bank of Canada officials' cautious stance on inflation has not only delayed potential interest rate cuts but also affected market confidence and cast a pall on the Zacks Oil and Gas - Exploration and Production - Canadian industry. OPEC's substantial spare capacity and Russia's increasing oil exports to China, which rose 30% year on year in April, have added to supply concerns. The lowered oil demand projections for 2024 have further weighed on the space. Meanwhile, the bottleneck in Canada’s oil transportation network hinders upstream operators from gaining access to a broader range of buyers to sell their products at better rates. Although macro challenges create uncertainties, there's resilience in the sector, especially for operators prioritizing growth and operational efficiency. Canadian Natural Resources Limited CNQ, Ovintiv Inc. OVV and Obsidian Energy Ltd. OBE emerge as stocks to watch, offering potential amid the prevailing economic headwinds.
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
Downward Pressure on Oil Prices: Recent dips in oil prices, with WCS crude futures falling below $70 per barrel, can be attributed to multiple factors. The Bank of Canada's cautious stance on inflation, requiring more signs of decline before the easing of interest rates, has impacted market sentiment. The sudden death of Iran's president created uncertainty, while the substantial spare capacity existing in OPEC countries remains a concern. Russia's increased oil exports to China, rising 30% year over year, have shifted global supply patterns. Moreover, the International Energy Agency (IEA) has revised its 2024 oil demand growth forecast downward by 140,000 barrels per day, highlighting weaker consumption in developed economies.
Positive Impacts of Aggressive Cost Reductions: The Canadian 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. 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-induced collapse in crude forced them to adopt a more disciplined approach to spending capital. These actions are expected to preserve cash flow and support balance sheet strength.
Lack of Pipeline Availability: According to energy consultant IHS Markit, oil production in Canada is expected to increase by around 900,000 barrels per day between 2020 and 2030. Despite this optimistic outlook, the country's exploration and production sector has struggled due to a shortage of pipelines. Essentially, pipeline construction in Canada has not kept up with the growing volumes of domestic crude oil, particularly the heavier sour crude from the oil sands, creating a bottleneck in infrastructure. As a result, producers have been forced to sell their products to the United States, Canada’s primary market, at discounted rates. With the cancellation of TC Energy’s Keystone XL pipeline following U.S. President Joe Biden’s revocation, Canadian oil sands producers have been facing further delays in addressing the takeaway capacity issue.
Zacks Industry Rank Indicates Bearish Outlook
The Zacks Oil and Gas - Canadian E&P is a nine-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #204, which places it in the bottom 18% of 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates fairly dull 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 bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are becoming pessimistic about this group’s earnings growth potential. While the industry’s earnings estimate for 2024 has gone down 28% in the past year, the same for 2025 has fallen 5.7% over the said timeframe.
Despite the dim 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 performed better than the broader Zacks Oil - Energy sector, as well as the Zacks S&P 500 composite over the past year.
The industry has gone up 27.3% over this period compared with the broader sector’s increase of 20.8% and the S&P 500’s rise of 26%.
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 Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization (EV/EBITDA) 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 5.40, significantly lower than the S&P 500’s 14.56. It is, however, above the sector’s trailing 12-month EV/EBITDA of 3.02X.
Over the past five years, the industry has traded as high as 13.53X, as low as 2.56X, with a median of 4.97X, as the chart below shows.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
3 Stocks in Focus
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 risk profile, thereby lending its results a high level of stability. Lower capital expenditure needs, accretive acquisitions and improving operational efficiencies have been the other positives in Canadian Natural’s story, which allowed it to generate a significant free cash flow of C$6.9 billion (post capital spending and dividends) in 2023.
CNQ beat the Zacks Consensus Estimate for earnings in two of the last four quarters and missed in the other two. It has a trailing four-quarter earnings surprise of roughly 5.5%, on average. Canadian Natural shares have gained 42.8% in a year. The stock carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank stocks here.
Price and Consensus: CNQ
Ovintiv: Ovintiv is an independent E&P operator with an 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 a higher liquids focus, greater scale and cost synergies. Ovintiv has done a commendable job of cutting its expenses in a Disciplined manner, which should boost free cash flow generation. Ovintiv’s cash flows will also receive downside protection from attractive oil and gas hedges.
Ovintiv beat the Zacks Consensus Estimate for earnings in three of the last four quarters and missed in the other. It has a trailing four-quarter earnings surprise of roughly 8%, on average. The #3 Ranked company’s Value and Growth Score of A and B, respectively, help it to round out with a VGM Score of A. With a market capitalization of around $13.1 billion, OVV has increased 51.7% in a year.
Price and Consensus: OVV
Obsidian Energy: An oil and gas producer, Obsidian Energy is an intermediate-sized firm with a well-balanced portfolio of high-quality assets, churning out approximately 32,000 barrels of oil equivalent per day. The company’s primary focus areas are in the Peace River, Cardium, and Viking areas of Alberta. Renowned for its efficiency among peers, Obsidian Energy’s world-class portfolio and experienced team has consistently delivered value to stakeholders.
The Zacks Consensus Estimate for 2024 earnings of Obsidian Energy indicates 34.7% growth. Headquartered in Calgary, OBE has a Value Score of A and a market capitalization of $573.7 million. OBE, carrying a Zacks Rank #3, has seen its stock go up 29.7% in a year.
Price and Consensus: OBE
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Canadian Natural Resources Limited (CNQ) : Free Stock Analysis Report
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Ovintiv Inc. (OVV) : Free Stock Analysis Report
