Stock Investing

These leading Canadian energy stocks have made substantial gains so far this year but are still trading below their fair values
By Vikram Barhat | 01/05/19

Things are looking up for the North American energy companies. Better than expected earnings and higher crude oil prices due to the Trump administration’s tighter sanctions on Iran’s oil are creating strong tailwind for the energy sector. As production cuts bring supply and demand into balance, the prices are expected to continue to tick higher. Further, the International Energy Agency forecasts solid increases in oil demand, led by China and India.

About the Author
Vikram Barhat is a Toronto-based financial writer specializing in investing, personal finance and small business. His experience working in various editorial capacities in digital and print media spans more than a decade across three continents. He has written for CNBC, BBC, The Globe and Mail, the Toronto Star and other publications. He can be reached on Twitter @vikrambarhath.

The trend has particularly favourable implications for the Canadian energy sector, one of the strongest pillars of the nation’s economy. It’s little surprise that energy stocks are on a roll. With a whopping 21% and 18% gains respectively for the S&P/TSX Capped Energy Index and the S&P 500 Energy index, energy is one of the best performing sectors on both sides of the border for the year to date, as of April 26, 2019.

These leading Canadian energy stocks have made substantial gains so far this year but are still trading below their fair values making them attractive options for those looking to gain or boost their energy exposure. These are well-managed corporations with strong balance sheets and are nicely positioned for greater profitability as oil prices and demand claw their way back to higher levels, according to Morningstar equity research.

Cenovus Energy Inc
Ticker:CVE
Current yield:1.45%
Forward P/E:14.64
Price:$13.65
Fair value:$19
Value:28% Discount
Data as of Apr. 25, 2019

Cenovus Energy (CVE) is an integrated oil company focused on oil sands development. The company’s operations also include conventional crude oil, natural gas liquids, and natural gas in Alberta, and refining operations in the U.S.

Cenovus is mitigating high costs of oil sands projects through solvent-aided process, or SAP, a technology that could significantly cut production costs. The implementation of this technology, which may be a few years away, could “provide Cenovus with the cost savings needed to be competitive with other marginal supply sources and generate free cash flow in a US$55/bbl environment,” says a Morningstar equity report.

“Based on our analysis, the solvent-aided process could eventually be the lowest-cost oil sands production, with most potential production having break-even prices around US$45/bbl WTI,” says Morningstar equity analyst Joe Gemino, stressing that the market is too narrowly focused on the firm’s temporary increase in leverage and vastly underestimating the long-term potential of solvent-aided production.

He puts the stock’s fair value at $19, pointing out “the stock is deeply undervalued and presents an attractive opportunity for long-term investors.”

Enbridge
Ticker:ENB
Current yield:5.78%
Forward P/E:20.49
Price:$50.88
Fair value:$62
Value:18% Discount
Data as of Apr. 25, 2019

Energy giant Enbridge (ENB) generates, distributes, and transports energy across Canada and the U.S. The company, whose assets are regarded among the best in the North American midstream sector, has a diverse portfolio including the Canadian Mainline crude pipeline system and other top-tier assets such as regional oil sands pipelines, U.S. and Canadian natural gas pipelines, and regulated utilities. Enbridge also generates renewable and alternative energy.

“Enbridge is positioned to benefit from growing oil sands supply dynamics with its Mainline system and regional oil sands pipelines,” says a Morningstar equity report, noting that “the regulated Mainline system generates attractive tolls and represents approximately 70% of Canada’s pipeline takeaway capacity.”

Although crude pipelines are the Canadian energy major’s bread and butter, the company also operates “natural gas distribution operations [which] benefit from regulated returns and provide the company with reliable cash flows,” says Gemino, who appraises the stock to be worth $62.

TransCanada Corp
Ticker:TRP
Current yield:4.66%
Forward P/E:16.3
Price:$64.25
Fair value:$70
Value:8% Discount
Data as of Apr. 25, 2019

An energy infrastructure company, TransCanada (TRP) owns and operates pipeline and power generation assets across North America. The company’s distribution network consists of more than 92,600 km of natural gas pipeline, as well as 4,900 km from the Keystone Pipeline system.

“TransCanada’s growth portfolio contains premier assets with top-tier contract quality,” says a Morningstar equity report, noting that the portfolio contains over $7 billion in expansion projects such as the Keystone XL and high-quality Mexico and U.S. natural gas pipelines. The company’s long-term contracts range from 15 years to over a century, the report notes.

A combination of factors including rising interest rates, uncertainty over the status of Keystone utilization, and the Federal Energy Regulatory Commission’s proposed tax disallowance have caused the stock to underperform over the past year. However, Gemino says that the time is right for long-term investors to capitalize on the stock’s considerable upside while collecting a steady stream of growing income.

“We expect TransCanada to meet its targeted 8%-10% annual dividend growth over the next two years, driven by a healthy pipeline of growth opportunities,” Gemino says. He pegs the stock’s fair value at $70.

Canadian Natural Resources Ltd
Ticker:CNQ
Current yield:3.41%
Forward P/E:12.32
Price:$40.5
Fair value:$45
Value:10% Discount
Data as of Apr. 25, 2019

One of the largest oil and natural gas producers in western Canada, Canadian Natural Resources (CNQ) focuses on the acquisition, development, production, marketing, and sale of crude oil, natural gas, and natural gas liquids. The company operates in western Canada, the U.K. sector of the North Sea, and offshore Africa.

“Canadian Natural’s ownership of midstream pipeline assets allows it to control the transport of a significant portion of its own production and lowers its transportation expenses and overall cost structure,” says a Morningstar equity report, noting the company’s cost structure compares favourably with peers.

Weakness in oil prices forced the company, like its peers, to contend with capital spending cuts and stalled growth. As a result, “Canadian Natural has shifted its focus to returning capital to shareholders in the form of dividends,” says Gemino, noting “its yield around 4% is at the head of the class among oil sands producers.”

On a more positive note, though, Canadian Natural’s recent purchase of a 70% working interest in the Athabasca Oil Sands Project is considered a bargain. “We expect cash break-even prices on the acquired assets to be below US$55/barrel West Texas Intermediate, including the initial capital outlay,” says Gemino, who estimates the stock to be worth $70, adding that “at current levels, the stock looks undervalued.”

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