The Motley Fool

The 2 Best Small-Cap Canadian Energy Stocks to Buy in 2020

Image source: Getty Images

It’s no secret that the Canadian energy industry has had its fair share of headwinds the last few years, and many of the stocks have been sold off heavily. This makes sense in the short term, as investors sold their shares, fearing the unknown and wanting to get out ahead of further share price collapses.

It has, however, created incredible value-investing opportunities for investors with a long-term mindset willing to wait out these issues for a recovery in the industry.

Once relief does come, a number of these stocks could see their values rise rapidly, and because the best companies pay a dividend, you can collect passive income while you wait for the real returns.

Two of the top small-cap energy stocks on the TSX to consider buying today are Peyto Exploration and Development (TSX:PEY) and Surge Energy (TSX:SGY).

Peyto

Peyto is a primarily a natural gas producer and one of the lowest-cost producers in the industry. The company is a perfect match for long-term-oriented shareholders, as the president and CEO Darren Gee is always making the best decisions for the company long term. One of the most important decisions that he has had to make is to reduce Peyto’s production while prices for natural gas trade at an unnaturally low level.

The reason Peyto is doing this is to keep more of its gas in the ground rather than producing it and selling it at these depressed prices.

Peyto could still make a profit on the gas if it did produce it, but instead, by leaving it in the ground, Peyto is betting that the gas will be worth substantially more in the future.

The share price took a hit over the last few years because of this reduction in production; however, the company has found a solid and sustainable level now, and there shouldn’t be any more reductions going forward. This means the dividend should continue to remain stable from here on out, especially because the dividend, which has a yield of more than 8.1%, has a payout ratio of less than 40%.

The stock trades at a trailing 12-month 4.7 times price to free cash flow, making Peyto possibly the cheapest stock in all of Canada.

Surge

Surge is primarily a light and medium oil producer with assets in Alberta and Saskatchewan.

The company has been growing its production substantially, up 75% since the second quarter of 2016, and has an extremely strong asset base, with just a 23% corporate decline rate.

Surge is estimating that oil will average US$56.50 this year for WTI, meaning it will have an all-in payout ratio of just 86%. This includes its sustaining costs as well as the dividend.

There is significant value for shareholders of surge over the long term, as the issues in the Western Canadian energy industry sort themselves out.

For now, though, Surge pays an attractive dividend that yields just under 10% and is expected to account for just 19% of Surge’s estimated 2020 adjusted funds flow.

It’s also strengthening its financials, like a number of its energy industry peers. In the first three quarters of 2019, Surge decreased its net debt by $84 million, and in its 2020 guidance it has stated it’s targeting another $20 million decline.

Like Peyto, the stock is clearly undervalued, especially when you consider the nearly 10% annual yield you’ll get from the dividend it pays to shareholders on monthly basis.

Bottom line

Although it’s not likely that a recovery in the Canadian energy industry will happen overnight, progress is being made, and these two companies are some of the lowest-cost producers you can buy.

The stocks are loaded with value and offering super-attractive dividend yields while you sit and wait, so get started on building yourself a small position today, and you can add to it when there is more progress in the sector.

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 Daniel Da Costa owns shares of PEYTO EXPLORATION AND DVLPMNT CORP.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss an important event.

Iain Butler and the Stock Advisor Canada team only publish their new “buy alerts” twice a month, and only to an exclusively small group.

This is your chance to get in early on what could prove to be very special investment advice.

Enter your email address below to get started now, and join the other thousands of Canadians who have already signed up for their chance to get the market-beating advice from Stock Advisor Canada.