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A Diversified Canadian Oil Stock Is Getting Ready to Unlock Value

Oil’s concerted rally in recent weeks, which now sees the North American benchmark West Texas Intermediate (WTI) trading at close to US$70 per barrel, has garnered considerable attention from investors. While some analysts remain pessimistic about the outlook for crude, there are signs that higher oil is here to stay, and this will benefit Canada’s beaten-down energy patch.

An interesting play on higher oil is Husky Energy Inc. (TSX:HSE). While oil has gained 15% since the start of the year, Husky’s shares have dropped by 1% in value, creating an opportunity for investors.

Now what?

The key reasons for Husky’s poor performance is that first quarter 2018 production fell by 10% year over year to just over 300 million barrels daily. That can be attributed to a range of factors, including the 2017 sale of legacy assets, lower heavy crude production because of the widening WTI/heavy oil differential, and reduced production from Husky’s Atlantic assets because operations were suspended for a short period.

Disappointingly, Husky expects its 2018 production to remain flat compared to 2017 mainly because of its decision to reduce heavy oil production because of the wide price differential to WTI.

However, higher oil coupled with Husky’s success at reducing expenses will give the integrated oil producer’s 2018 earnings a healthy lift. First-quarter 2018 operating costs were $13.33 per barrel, which is a 3% reduction year over year.

Importantly over the long term, Husky’s production will expand at a decent clip. The company has a number of assets under development, including the Liwan Gas Project, which is forecast to commence full commercial production in 2020 as well as the Madura Strait gas development, where activity is being ramped up to ensure that production reaches full capacity by the end of 2018. Husky has also made significant operational changes at the field to ensure that production could restart at the West White Rose field located in the Atlantic after operations were suspended by the local petroleum regulator. That along with further development activity at that field will give Husky’s oil output a solid lift.

Husky’s downstream operations, which include upgrading and refining businesses, are performing solidly. For the first quarter 2018, net income from Husky’s upgrading operations, where it transforms heavy oil into lighter synthetic crude, more than doubled to $109 million compared to $48 million for the equivalent period in 2017.

Furthermore, net income from Husky’s refining business popped by a very respectable 87% year over year to $28 million. There is every sign that Husky’s downstream operations will deliver solid earnings growth for the foreseeable future, further buoying Husky’s bottom line.

Another appealing aspect of Husky’s operations is its diversified portfolio of quality oil and natural gas assets, which hold net reserves totaling 1.6 billion barrels of oil equivalent. Those reserves have been determined to have a value of $16 billion after tax, which equals $16 per share. While that is marginally lower than Husky’s current share price, that value will grow because it was calculated using forecast prices for oil, which were significantly lower than the current market price.

So what?

Husky appears attractively valued, and the company is well positioned to manage the short-term headwinds affecting its operations. There is every indication that over the medium to long term, production will grow at a solid clip, which, in conjunction with higher crude, will give Husky’s earnings a healthy bump. As its operations improve and oil’s value rises, Husky’s shares will appreciate.

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Fool contributor Matt Smith has no position in any stocks mentioned.

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