Oil Stocks in Canada: Are They Still Good Buys?

Oil stocks experienced a rout last week, but the underlying supply-demand imbalance makes them strong buys, nonetheless.

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The TSX’s energy sector had a great start to 2022, gaining nearly 70% during the first quarter. However, it seems that its meteoric climb due to rising crude prices is over. While the sector remains the top performer, oil stocks sputtered this month and are now up by only 35.42% year to date.

In 2021, the energy sector delivered an annualized price return of 41.8%, the highest for the year among all the 11 primary sectors. But because of declining commodity prices due to recession fears, oil stocks pulled the broader market down last week. They collectively lost 4.58% in the last five trading days.

Profit-taking was also evident when high flyers like Baytex Energy (TSX:BTE)(NYSE:BTE) and MEG Energy (TSX:MEG) declined 12% and 9.5%, respectively, on June 22, 2022. Still, both stocks recovered lost ground when they advanced 9.55% and 7.23%, respectively, to end the week. Should investors avoid buying oil stocks because of the recent volatility?

Demand is still rising

Eric Nuttall, a partner and senior portfolio manager at Ninepoint Partners LP, said, “Energy investors themselves are being paralyzed by fear right now. The fear of the impact on future demand from a recession. I think the average person thinks that if you’re going through a recession, demand falls. That’s wrong. The rate of demand growth moderates, but demand is still rising.”

Strong earnings growth

Baytex’s outperformance this year is due to its strong cash flows and earnings growth. At $6.08 per share, the trailing one-year price return is 149.18%, while the year-to-date gain is 55.5%. Had you invested $20,000 in this energy stock a year ago, your investment would be worth $49,836.07 today.

The $3.46 billion oil & gas company reported impressive financial results in Q1 2022. In the three months ended March 31, 2022, net income reached $56.85 million compared to the $35.35 million net loss in Q1 2021. The quarter’s highlights were the year-over-year increases in production (3%), adjusted funds flow (78%), and cash flows from operating activities (64%).

Baytex also reduced its net debt by 10% to $1.28 billion. According to management, it will remain intensely focused on maintaining capital discipline and driving meaningful free cash flow. Besides allocating around 25% of its annual free cash flow (FCF) to direct shareholder returns through share buybacks, Baytex will channel the remaining FCF towards debt reduction.

Record quarterly results

MEG Energy’s total return in 3.01 years is a fantastic 235.03% (49.41% CAGR). At $17.79 per share, current investors enjoy a 52.05% year-to-date gain. Like Baytex, this $5.46 billion energy company utilizes steam-assisted gravity drainage extraction methods to develop innovative enhanced oil recovery projects.

In Q1 2022, the $587 million adjusted funds flow, and funds flow from operating activities were new records for MEG. The year-over-year increase in revenue was 67.5%, while net earnings were $362 million compared to the $17 million net loss in Q1 2021. Derek Evans, MEG’s president and CEO, said the company is well positioned to accelerate debt repayments and initiate share buybacks.

FCF to shareholders

Nuttall reiterated that the underlying demand-supply imbalance still favours oil stocks. Because of elevated crude prices, most energy companies commit to returning more FCFs to shareholders instead of expanding production.

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 Christopher Liew has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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