Contrarian investors are always searching for unloved stocks that could hold strong long-term upside potential.
Let’s take a look at Cenovus Energy Inc. (TSX: CVE)(NYSE: CVE) and TransAlta Corp. (TSX: TA)(NYSE: TAC) to see why they might be interesting picks.
Cenovus
Cenovus was a $30 stock five years ago. Today, investors can pick it up for about $11 per share. The oil rout hit Canadian producers hard, but Cenovus has really taken it on the chin, especially when compared to its oil sands peers.
What’s up?
The company decided to double down last year when it spent $17.7 billion to buy out its oil sands partner, ConocoPhillips. On the surface, the deal appeared to make sense. Cenovus already operated the assets and instantly doubled both production and the reserve base.
However, the market didn’t like the deal, and Cenovus saw its share price plummet as a result. Investors were concerned that the company had bitten off more than it could chew given the downtrend in oil prices. Cenovus took out a $3.6 billion bridge loan to cover the purchase costs while it shopped non-core assets. With oil falling through the first half of last year, the market wasn’t convinced that Cenovus would find buyers for the properties at high enough prices.
Fortunately, oil recovered through the summer and into the end of 2017, and Cenovus managed to sell its facilities for enough money to cover the bridge loan.
The current issue lies with pipeline capacity to get oil sands product to international markets. Resistance to major pipeline projects is strong, and while that is likely to remain the case, the industry is confident that the situation will eventually get resolved.
If you believe that Canada is serious about getting its oil to foreign buyers and are confident that pipeline capacity will eventually increase, Cenovus should be an attractive contrarian bet today.
TransAlta
TransAlta used to be a go-to name for Canadian dividend investors, but a perfect storm of high debt, falling power prices, and negative sentiment toward coal-fired power generation hit the company hard, forcing management to reduce the payout several times in order to preserve cash flow.
How bad has it been?
TransAlta current sells for $7 per share, hitting as low as $4 in early 2016. Five years ago it fetched $15, and a decade ago the stock was above $30.
Power prices remain under pressure, but a number of the other issues should be solved. Alberta came to an agreement with TransAlta and its peers for transition payments to help the companies close coal-fired plants or switch them to nautural gas. TransAlta is receiving close to $37.4 million per year under the arrangement through 2030, and is committed to remaining a significant player in the Alberta market.
The debt is falling and the existing dividend, which yields 2.2%, should be safe.
In addition, TransAlta’s 64% stake in TransAlta Renewables (TSX: RNW) is currently worth $1.9 billion. TransAlta’s total market cap is just $2 billion, so the market isn’t putting much value on the assets that have not been dropped down into RNW.
It may take some time for things to turn around in the power market, but if you have the patience, TransAlta might be worth considering for a small position in your contrarian portfolio.
The bottom line
Buying beaten-up stocks takes some courage, but when you find the right companies, the payoffs can be significant.
