Energy Stocks Remain A Buy Despite Strong Performances In The Last Month

Summary

• It's very difficult to buy something that keeps going up, but a broader perspective is needed in light of the strong recent performance.
• Energy stock prices have only just recovered back to the "price war narrative" level.
• Names we track are still trading at very high free cash flow yields assuming $57/bbl WTI.
• Looking for a helping hand in the market? Members of HFI Research get exclusive ideas and guidance to navigate any climate. Get started today »

Welcome to the valuation edition of Oil Markets Daily!

It's very difficult to buy something that keeps going up, but a broader perspective is needed in light of the strong recent performance.

Take Cenovus Energy (CVE) for example, it has returned 187% since we bought it in March, but despite these gains, it is still down ~50% from where it was last year.

And in our mind, the recent price performance is simply correcting a material narrative shift since March.

Rewinding back to March, Saudi had just declared an oil price war following a botched OPEC+ meeting. The sudden and dramatic gap lower in energy names came as investors fretted over the coronavirus demand destruction, but also the destruction of the energy market narrative that Saudi will be the responsible producer.

Practically everyone sold and turned into a bear causing some of these energy stocks to trade to a valuation tantamount to bankruptcy. In March, the valuations got so out of whack that even solvent durable producers like Suncor (SU) traded to a valuation of ~25% FCF yield. The very same Cenovus, which didn't have any debt due in the next three years, traded to a valuation of 100% FCF yield. Meg Energy (OTCPK:MEGEF) traded above 100% FCF yield to ~140% at the very bottom.

These valuations were clearly unsustainable because it implied that oil prices will never return to $57/bbl, which was what we used as a sustainable FCF price scenario. In addition, the investment community just thought simply that global oil storages would hit tank top and cause oil prices to go to negative. Heck, even CME started getting ready for Brent to go negative, and one analyst said it's not "hard to fathom" Brent going to -$100/bbl.

Well, a month later, and none of those things happened. But instead, energy stocks rallied like no other, and the name of the game going forward is that there's a massive supply deficit on the horizon with no one there to rescue us out of it.

So even though you may think that energy stocks have gone up too much, a bit of perspective is seriously needed. We really just went from "oh my god, everything is going to zero" to "hey, things aren't so bad anymore".

Now while the returns generated from this step change are seriously insane, the bigger picture outlook is even better. Now picture a market where it goes from "hey, things aren't so bad anymore" to "wow, these producers generate a lot of money at these prices."

Close your eyes, grab a cup of coffee, and tell me whether you think these names should still be trading at these free cash flow valuations.

Ok, now open your eyes and I think you get why we are saying they continue to be a buy.

Analyst’s Disclosure: I am/we are long MEG.TO, GXE.TO, CVE.TO, BTE.TO, TVE.TO, SU, CPG, CNQ, WCP.TO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Wilson is a director for Gear Energy.