Canadian energy company shares are trading at levels not seen since the depths of the 2008 crisis, levels that can only be justified if the global economy falls into another recession and oil prices drop by half. Any outcome better than such a scenario and the sector will rally.
The entire Canadian equity market has been hit hard this year. The iShares S&P TSX 60 ETF (XIU-TO) is down 8% year to date and down 14% from its March high. But energy firms have been hit harder. The iShares TSX Capped Energy ETF (XEG-TO) is down 18% year-to-date and 27% since March, bringing its price, at just over $16, down to October 2008 levels.
Individual firms are even worse off. Year-to-date, Suncor (SU-TO) and Canadian Natural Resources (CNQ-TO) are down about 25%, and Talisman (TLM-TO) a gut-wrenching 37%. The one major exception is Cenovus: born after the crisis, it has stayed in the black for the year to date.
On a valuation basis, these stocks, and by extension, XEG, are cheap. Forward price-to-earnings ratios are in the 8 to 9 times range for all of them except Cenovus at 13.6 times. The same ratios were around 8 times in the autumn of 2008. They all have debt to equity ratios of less than 50%, a good thing if a recession does occur.
Their prices are so low, in fact, that one firm, Suncor recently said it would buy back up to $500 million worth of its shares or about 1.1% of outstanding issuance by next September.
One reason they are cheap is political and environmental risk. “Your oil is really dirty”, they say, flashing National Geographic photographs of birds and bitumen-filled tailings ponds. “But it is more ethical than oil from some misogynistic medieval kingdom,” we reply.
Unconvinced, environmentalists in the United States, our main oil buyer, are working to block Canadian oil-sands oil. In August, 1,200 protesters at the White House condemned TransCanada’s (TRP-TO) proposed Keystone Pipeline. Two weeks ago, a list of Nobel Prize winners added their names to the protest. If the $7 billion pipe is built, which is likely, it will transport oil from Alberta nearly 3,000 km to refineries on the U.S. Gulf Coast.
However, even in the unlikely event that the United States does close its doors, I suspect there would be no shortage of demand from less finicky buyers just as lumber from British Columbia, rejected by the United States several years ago, has found willing Asian buyers.
However, most of the price decline is attributable to recession fears, in Canada and globally. Here at home, expectations for economic growth have been cut. The International Monetary Fund now expects Canada to grow at about 2% this year and next, down from its earlier expectation of about 2.8%. The latest data shows job growth stalled this summer, with unemployment stuck at just over 7%.
The IMF also revised its expectations for global growth for 2011 and 2012 down to about 4.0% from about 4.3% earlier.
However, even with the slower growth, oil consumption is expected to grow and prices, according to the U.S. Energy Information Administration, are expected to remain in the mid-$90s per barrel into 2012 despite the slower economic growth. The price has ranged between $80 and $110 for the last year.
That is a far cry from late 2008, when prices for WTI crude fell to about $40 a barrel before recovering to the mid-$70 range 8 months later. The difference back then was the world was on the edge of a financial precipice.
And while we are certainly facing economic problems today – Euro debt, U.S. joblessness – they are not of the same magnitude as in 2008. If this view is correct, then the energy sector is an attractive investment.
The dominant Canadian energy ETF is iShares’ XEG with nearly $800 million in assets. It holds 55 companies, mainly oil but Encana represents the gas sector with a 5.7% weight. Suncor and CNR are the biggest holdings with about 15.7% and 12.4% of the allocation. XEG’s dividend yield, at about 2.2%, is lower than the broad market, but XEG will likely outperform the TSX 60 once it rebounds.
Disclosure: We may hold positions in any and all securities mentioned in this report.
|Benchmark||S&P TSX Energy Index|
|52 Week High||$22.74|
|52 Week Low||$15.01|
|Avg Daily Volume||1.08 Million Shrs|
|Avg Daily Volume ($)||$16.25 Million|
|Total Market Cap||$879.73 Million|
|ETF Annual Fee||0.55%|
|ETF Trading Currency||CAD|
|ETF FX Exposure||CAD|
|Correlation to S&P 500||81.0%|
|Return to Risk Ratio||-0.14|
|Use of Leverage||No|
|Use of Futures||No|
|6 month Return||-28.86%|
|1 Year Return||-10.44%|
|2 Year Return||-13.69%|
|3 Year Return||-21.70%|
|Dividend Yield (TTM)||5.14%|
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© 2011 archerETF Portfolio Management is a division of Bellwether Investment Management, a discretionary portfolio manager registered with the Ontario Securities Commission. This report is provided for information only and does not constitute investment advice. While we believe the information to be accurate and timely, we make no claim or warranty to that effect. Please seek professional advice before making any investment decision. We may hold positions in any or all securities discussed in this report.