What’s your return expectation when investing in stocks? A yearly return of 10%-15% seems reasonable, right? That’s the case for many. But energy TSX stocks have delivered multi-bagger returns since the pandemic sell-off.
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TSX energy stocks broke through the roof
For instance, stock in Obsidian Energy (TSX: OBE)(NYSE: OBE), a small-cap oil producer, zoomed from $0.5 apiece during the mid-2020s to close to $9 levels today. That’s a handsome 1,700% return in just 20 odd months. InPlay Oil Corp. (TSX: IPO) stock also paraded a similar movement and returned 2,600% in the same period.
Indeed, these small caps were trading way under the radar during the worst of the pandemic and looked highly risky. However, those who perfectly sensed the growth potential and entered understanding the risks must be sitting on solid gains today.
Baytex Energy (TSX: BTE)(NYSE: BTE) and NuVista Energy (TSX: NVA) are also among the gainers. They have soared 1,300% and 1,700% since the pandemic crash.
Notably, the four names are currently trading way below the industry average valuation multiple. That means there could be more upside, even from the current levels.
What led to the epic ascent?
The fundamental theme that has helped these small wonders reach the moon has been the free cash allocation. Almost all energy companies have seen superior free cash flow growth since mid-2020 due to rallying oil and gas prices.
So, instead of using the excess cash to increase production, energy producers have chosen to deploy a major portion of this capital to improve their balance sheet strength. They witnessed a deep dent on their balance sheets early during the pandemic. Thus, aggressive debt repayments have been the trend across the sector since last year.
The additional free cash is expected to go back to shareholders in the form of dividends or share buybacks. So, energy investors have been seeing value unlocking in more than one way since last year.
Obsidian Energy recently issued an upbeat operational outlook for 2022. It expects higher production and in turn, superior free cash flows this year. A majority of the excess cash will likely go to debt repayments.
A $1.8 billion oil and gas producer NuVista mainly operates in the Western Canadian Sedimentary Basin. Apart from increasing production, it also plans to bring down its total debt and get in sound financial shape.
The gains from these smaller energy stocks are indeed noteworthy. Their larger counterparts have returned 200% on average in the same period. Not underwhelming at all, but still way inferior relative to smaller peers.
Should you buy TSX energy stocks?
The macro picture has been quite helpful for energy investors of late. Returning demand, constrained supply, and geopolitical tensions have all fuelled energy commodity prices higher. As a result, crude oil is up almost 65% in the last 12 months, and experts see it reaching US$100 a barrel in the short term.
As stated, these small-cap stocks do not look expensive compared to the industry average, despite the steep rally. However, these are still riskier bets, given their size and their volatile stocks. If oil and gas prices turn weak from here, these stocks could see an outsized impact.
At the same time, if energy prices remain supportive, TSX energy stocks could continue their super bull run this year as well. Moreover, superior earnings growth prospects, reasonable valuations, and a favourable macro situation will likely keep the rally going in 2022.
