Softer oil prices have sent shockwaves through markets, with crude now at its lowest point since 2010. Share prices of Canadian energy stocks have plunged, with the S&P TSX Capped Energy Index down 11% for the quarter to date, compared to a mere 1% for the broader S&P TSX Composite Index. But of even greater concern for investors are claims among some analysts that the price of crude is set to fall even further. With that in mind, what should investors do next? Focus on companies with solid balance sheets and high-quality assets During times of market distress, a fundamental…
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Softer oil prices have sent shockwaves through markets, with crude now at its lowest point since 2010. Share prices of Canadian energy stocks have plunged, with the S&P TSX Capped Energy Index down 11% for the quarter to date, compared to a mere 1% for the broader S&P TSX Composite Index.
But of even greater concern for investors are claims among some analysts that the price of crude is set to fall even further.
With that in mind, what should investors do next?
Focus on companies with solid balance sheets and high-quality assets
During times of market distress, a fundamental rule for investors is to focus on companies with strong balance sheets and high-quality assets. In the case of oil producers, this means identifying those companies with low degrees of leverage coupled with oil assets that have low decline rates and production costs.
For me, the standout company in this regard is Crescent Point Energy Corp. (TSX: CPG) (NYSE: CPG).
Through a range of accretive acquisitions made over the years, it has amassed a portfolio of high-quality, low-decline-rate oil assets, giving it reserves of over 640 million barrels of oil. More important, only around 40% of those reserves are developed and producing, giving Crescent Point a substantial drilling inventory, removing the need to keep making acquisitions in order to grow production.
The quality of these oil reserves can be seen in the high operating margin, or netback, that Crescent Point is able to generate per barrel of oil produced. At $51.25 per barrel for the third quarter 2014, it was the highest in the patch and indicates oil would have to fall even further for its profitability to be significantly impacted.
Coupled with this portfolio of high-quality assets, Crescent Point has a low degree of leverage, with net debt less than 1.4 times cash flow. This not only reduces the costs associated with maintaining debt, but leaves Crescent Point well-positioned to utilise further debt if the circumstances arise.
It even appears attractively priced, with an enterprise value of eight times EBITDA, while consistently paying a dividend yielding in excess of 7%.
Look to the integrated energy majors
Another means of minimising the fallout from softer crude prices is investing in the integrated energy majors, of which Canadian Natural Resources Ltd., Suncor Energy Inc., and Husky Energy Inc. (TSX: HSE) offer the best value.
All three companies have substantial portfolios of highly diversified onshore and offshore assets that allow them to access both West Texas Intermediate and premium Brent pricing. This also reduces their dependence on the U.S. as a key export market, being able to access European and Asian refining markets.
But more important, their upstream, or refining, operations allow them to more effectively manage margins and pricing differentials between Canadian crude blends and WTI.
They also have the financial strength to weather any concerted downturn in the price of crude, with low leverage. Canadian Natural Resources has a debt-to-equity ratio of 0.5, while Suncor’s is 0.3, and Husky’s is a mere 0.2.
All three companies, after the recent sell-off of energy stocks, are attractively priced, with Canadian Natural Resources enterprise value only six times its EBITDA, and both Suncor and Husky at only five times.
Each of these integrated energy majors also has a history of consistently paying a steadily growing dividend, which means patient investors will continue to be rewarded for their loyalty as they wait for share prices to appreciate.
These characteristics, coupled with attractive valuation multiples, make now the time for investors to consider allocating a portion of their portfolio to any one or a mix of these four companies. This will give investors exposure to the much-anticipated rebound in oil prices.
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Fool contributor Matt Smith has no position in any stocks mentioned.