What happened?
The energy sector has undoubtedly been the outperformer, and small-caps energy stocks have been on a roll recently. One such Canadian oil and gas stock, Surge Energy (TSX: SGY), zoomed 22% last week, taking its monthly gain to more than 56%. Notably, crude oil continued to soar higher last week, with WTI crude reaching record levels of US$84 per barrel.
So what?
Surge Energy has been on fire since the fourth quarter of 2021, notably outperforming peers. It is a $520 million oil and gas exploration and production company in Western Canada.
The company expects $105 million in free cash flows in 2022 when WTI is at US$70 per barrel level. With oil looking in great shape to rally even higher from current levels, Surge Energy could see a notable surge in its free cash flows.
Surge Energy suspended its dividend early during the pandemic, when cash preservation became a necessity. However, the company’s balance sheet has improved substantially in the last few quarters.
In addition, it completed two strategic acquisitions of Astra Oil and Fire Sky Energy for a combined value of $218 million in Q4 2021. Surge Energy could consider resuming shareholder payouts if oil and gas prices continue to rally.
Note that Surge Energy will likely use incremental cash flows for debt repayments. This has been the trend across the industry.
Energy companies’ balance sheets have notably improved in the last few quarters with aggressive debt repayments led by rapid cash flows. Interestingly, they have focused more on maintaining capital discipline instead of increasing production amid the increasing demand.
Now what?
Oil and gas prices should continue to trade strong given strong demand amid full re-opening and constrained supplies. Moreover, the rally so far indicates that energy investors are least bothered about the Omicron fears and demand will remain robust. Thus, energy companies could see superior financial growth and a sustained balance sheet recovery.
Small-cap stocks like Surge Energy could see momentum continuing with its better earnings growth prospects. Its recently completed acquisitions and strong liquidity position place it well to play the oil rally this year.
Above all, its appealing valuation indicates huge growth potential if the strength in energy commodities lasts through 2022 and beyond.
