Value investors have been paying more attention to the Canadian energy sector.
Since September, nearly every domestic oil and gas company has lost a good chunk of value. Buying in a bear market can be tough, but as Warren Buffett always says, it pays to be greedy when others are fearful.
In this case, he was willing to put his money where his mouth is. In February, he disclosed a 10.8 million share stake in Suncor Energy Inc.
Which other energy stocks are now in the bargain bin? Down around 40% from their annual highs, Husky Energy Inc. (TSX:HSE) and MEG Energy Corp (TSX:MEG) are solid candidates. Let’s take a closer look.
A major difference in risk
In a bear market, companies that over-extended themselves in the previous cycle often meet their doom. The stock market may reward companies for expanding aggressively while times are good, but bloated balance sheets and an inability to reinvest when prices are low can come back to haunt them.
Given that a larger company has more assets to liquidate for fast cash with a greater ability to issue additional debt and equity, larger companies can often use their weight to gobble up smaller, cash-starved competitors during a bear market, and scale can usually compensate for poor decision making. That makes Husky’s $14 billion market cap an attractive attribute versus MEG Energy’s diminutive $1.8 billion valuation.
In January, Husky attempted to use its financial power to buy MEG Energy outright. On January 17, Husky dropped its bid after it failed to secure approval from more than two-thirds of shareholders. MEG Energy shares lost one-third of their value that day, as the Husky buyout offer had been propping up shares.
Now that both companies are set to remain independent, which stock is a better buy?
Avoid MEG Energy and consider Husky
MEG Energy is in a tricky place after Husky dropped its bid. While the event was driven by the lack of shareholder approval, there was growing sentiment that Husky no longer wanted the assets.
“Since the offer commenced 105 days ago, there have been several negative surprises in the business and economic environment,” read Husky’s press release following the buyout termination. The latest supply issues in Alberta continue to overwhelm transportation infrastructure, causing regional selling prices to fetch big discounts versus its U.S. counterparts.
An analyst at Eight Capital noted that there’s only a “slim chance that another company would consider purchasing MEG given that Husky could not gain enough shareholder support.” The fact that MEG Energy produces low-quality oil only compounds this problem.
Now on its own, MEG Energy faces an uncertain future. Husky, however, can continue to grow stronger.
Currently, Husky has one of the best balance sheets in the industry, along with impressive cost break evens. This year, it should be able to produce a profit as long as prices exceed US$40 per barrel. Management anticipates achieving a US$37 per barrel breakeven level within three years.
After its failed MEG Energy bid, the company decided to refocus on “capital discipline,” but don’t be shocked to see the company make a bid for another struggling competitor. This time, it must avoid buying a company with poor assets like MEG Energy. If it can find a quality acquisition at a bargain price, Husky Energy shares would be a winner.
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Fool contributor Ryan Vanzo has no position in any stocks mentioned.