Canadian Natural Resources: A Solid Undervalued Play in Canada’s Oil Patch

The company has a number of catalysts at its back.

| More on:
The Motley Fool

I’ve spent the past month investigating the challenges facing Canada’s oil sands industry in an attempt to determine whether the industry is sustainable. In the final article of that series, I concluded that despite the industry’s many challenges, it is too early to call it unsustainable. I also found that many of the major companies operating in the industry now sport attractive valuations.

One company that stands out is Canadian Natural Resources (TSX:CNQ)(NYSE:CNQ), which is set to report record production for the third quarter of 2013.

Record results
Canadian Natural Resources is set to formally report its third-quarter 2013 results on Nov. 7, but it’s already clear that the company has had a strong operational quarter. Oil production for the quarter has already been reported: up 12% quarter over quarter to 701,000 barrels.

As such, I’m expecting significantly higher revenue and cash flow. Not only because of the record production, but because the price of crude surged to a one-year high in August 2013. Canadian Natural Resources recently announced that it estimated third-quarter 2013 cash flow to be up 38% quarter over quarter to $2.4 billion. All of which is to say: Investors should see a nice bounce in earnings per share, which should eventually translate into a higher share price.

Appears undervalued
When considering a number of key ratios used to value oil companies, Canadian Natural Resources already appears undervalued. So any growth in cash flow and earnings does not appear to be baked in.

At the time of writing, the stock is trading at an enterprise value of 7 times EBITDA and 9 times its proven oil reserves; it’s also trading at 6x its cash flow per share.

These are particularly attractive valuation ratios and are significantly lower than the industry average for similarly sized independent oil explorers and producers. Let’s take a closer look to see how this compare to its competitors.

Company EV-to-EBITDA EV-to-Reserves Price-to-Cash-Flow
Suncor 5 14 6
Husky Energy 6 26 6
Canadian Nat Res 7 9 6
Cenovus 7 13 7
Talisman 8 6 9
Imperial Oil 9 12 11

Source: Company Financial Filings and Yahoo! Finance.

Clearly Canadian Natural Resources on the basis of all three ratios appears undervalued in comparison to its competitors. Only Suncor appears to be almost as attractively valued, while Imperial Oil looks to be the most expensive on a comparative basis.

However, if we look at each company’s return on capital employed (or ROCE), as explained in a recent article by fellow Fool Robert Baillieul, Imperial Oil is the star.

Company

ROCE 5-Year Average

Imperial Oil

25%

Husky Energy

12%

Cenovus

11%

Canadian Nat Res

10%

Suncor

8%

Talisman

5%

Source: Company Filings and Fool.ca.

In order to grow, Canadian Natural Resources has engaged in a number of low-margin, high-development-cost projects, which historically has been a symptom of oil sands development and production. But with it now focused on growing its higher-margin crude production and controlling costs — which will boost margins — its ROCE should improve.

Foolish bottom line
I am expecting Canadian Natural Resources to report strong operational results for the third quarter.

If I’m right about that, and if paired with solid oil reserves, growing production, and stronger cash flow, the company appears to be a good value at current prices.

 

More from The Motley Fool
Interested in a top small-cap stock idea from The Motley Fool’s senior investment advisor? Click here to download a FREE copy of “A Top Canadian Small Cap for 2013 — and Beyond.

The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool Canada’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.

Follow us on Twitter and Facebook for the latest in Foolish investing.

Fool contributor Matt Smith does not own shares of any companies mentioned. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

More on Investing

Oil pumps against sunset
Energy Stocks

Is it a Good Time to Buy in the Energy Sector?

Boosted by a very bullish supply/demand environment, energy stocks like Canadian Natural Resources and Tourmaline have much further to go.

Read more »

Investing

2 Stocks to Buy Offering Better Value Than Air Canada

Air Canada has been a popular stock for years, but despite its low price, these two picks are much better…

Read more »

money cash dividends
Investing

How to Make $373/Month in Passive Income With These 2 TSX Stocks

You could bring in passive income of $4,482 annually, or $373 per month!

Read more »

clock time
Stocks for Beginners

3 Stocks to Start Investing Today

Looking for a set of stocks to start investing today? Here are some great options that offer growth and income…

Read more »

investment research
Dividend Stocks

Young Investors: Create Cash Flow With This Top Dividend Stock

If you're a young investor looking for cash flow, you need a strong dividend stock and solid banking program designed…

Read more »

Illustration of bull and bear
Investing

Is the Stock Market Selloff Over?

Throughout this week, many stocks have been gaining value and rebounding from their lows. So, is the stock market selloff…

Read more »

potted green plant grows up in arrow shape
Investing

Retirement 101: How Investors Can Turn $20,000 Into $500,000 in 25 Years

These top TSX dividend stocks have made some investors rich.

Read more »

Hand writing Time for Action concept with red marker on transparent wipe board.
Dividend Stocks

3 Superb Dividend Stocks I’m Ready to Buy

The market is full of great options for income-seeking investors. Here are three superb dividend stocks to buy now.

Read more »