While the rest of the world lamented the decline in crude and the fall in energy stocks, value investors were practically rubbing their hands together in glee at the sight of such carnage.
Sure, the underlying fundamentals in the market don’t look great right now, but that’s okay. At some point in the next one to five years, those fundamentals will change, and the sector will start to look attractive again. The secret to successful value investing is to buy when things look terrible, and then sell when things look quite good. It’s somewhat counter intuitive, but it’s been proven to work.
I’m not sure we’ve reached the bottom of the energy crisis, but I do know that many companies in the sector are once again flirting with lows experienced back in December, even though oil is nearly $15 per barrel higher. This is the fault of Alberta’s newly elected NDP government, which has strongly hinted that higher royalties are coming. This is obviously bad news for the sector.
But it’s also the very definition of a temporary problem. I guarantee that nobody will be talking about this once crude hits $100 per barrel again. If you’re a believer in the sector eventually recovering, then these two producers are ridiculously cheap. Let’s take a closer look.
Canadian Oil Sands
Even before crude collapsed, Canadian Oil Sands Ltd. (TSX:COS) wasn’t exactly in most investors’ good books. The company seemed to constantly disappoint, coming short on production targets, while letting costs slowly creep up. The company was also one of the earliest to cut the dividend, which led to further selling.
All that downside pressure has made shares pretty darn cheap. I like looking at it this way. The company has an enterprise value of approximately $7.6 billion. Its share of the proved and probable reserves of the Syncrude oil sands project is 1.6 billion barrels, which means investors are paying less than $5 per barrel of oil in the ground—debt included. Yes, I realize there are costs to getting this oil out, but there’s enough there to keep the company busy for another 40 years.
There’s also another 2.1 billion barrels of contingent and prospective reserves, which will likely become economically viable at some point in the future. That’s another 45 years’ worth of potential production that investors are getting for free.
Penn West Petroleum
Much like Canadian Oil Sands, Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE) didn’t do much to endear itself to investors while the energy sector was hot. The previous management team let costs get out of control, and seemingly had no strategy, resulting in a mishmash of assets around the world. And then, in an attempt to make themselves look better, the previous managers listed millions in operating costs as capital costs, allowing it to report better cash flow numbers.
Not only did the new management team have to clean up the mess, but now they’re dealing with a terrible crude market. But new CEO Dave Roberts is up to the challenge, selling off assets to pay down the debt, cutting drilling costs, and cleaning up the books. Even in today’s challenging market, the company is still managing to get good money for its assets.
Because of those previous issues and the company’s still inflated debt load, shares are cheap on pretty much every metric. They trade at approximately a quarter of book value, which gives investors a huge margin of safety. The company is also among the cheapest in the sector when you look at price per flowing barrel. Perhaps the quality of production isn’t the greatest, but that’s changing with management’s focus on higher quality areas.
Essentially, both Penn West and Canadian Oil Sands are leveraged plays on the price of crude. If the commodity recovers, both stocks soar. It’s the nature of buying companies that are dependent on the price of a commodity. But oil is an integral part of the world’s economy. I’m confident it’ll recover at some point, taking both stocks much higher with it.
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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.
Fool contributor Nelson Smith owns shares of CANADIAN OIL SANDS LIMITED and PENN WEST PETROLEUM LTD.