Canadian energy stocks turned higher this week after the oil cartel’s epic output cut. Many TSX upstream stocks look appealing from a valuation perspective at the moment, given their earnings visibility and focus on shareholder returns. However, one name that significantly differentiates itself from peers is Whitecap Resources (TSX:WCP).
What’s next for WCP stock?
Energy producers have been in a sweet spot since the pandemic, mainly due to higher oil prices. Apart from the strong price environment, they have shown admirable capital discipline since late 2021. Instead of allocating more capital for production growth, they have deployed excess cash to prepay debt and boost shareholder returns. Although inflation is turning out to be a major problem for them, Canadian energy producers seem in great shape for 2023.
Despite rising costs, Whitecap Resources aims for a decent 12% production growth this year, higher than its peers. It will produce 161,000 barrels of oil equivalent per day this year, of which 64% will be liquids. It has significantly increased production in the last few years, thanks to its acquisitions of XTO Energy and TimberRock Energy.
Whitecap has been on an acquisition spree since 2021, which has come at interesting times as companies are flush with cash. Plus, these acquisitions have expanded its footprint in the highly economical Montney formation. These are low-decline assets that produce premium-priced light oil, facilitating higher margins.
Financial growth and balance sheet improvement
Energy companies have repaid billions in debt since late 2021 and strengthened their balance sheets. To be precise, Canadian E&P companies had a leverage ratio close to 3x in the pre-pandemic era, which has now dropped close to 0.5x.
Whitecap Resources has debt leverage of around 0.7x, which is evident considering its acquisitions. However, it aims to reach net debt levels of $1.3 billion from $1.8 billion currently, by next year.
Higher debt was one of the major concerns for energy investors. However, this has changed substantially in the current cycle. Energy companies have some of the healthiest balance sheets in history this year.
Whitecap Resources has announced that when it achieves the above debt target, it will allocate 75% of its free cash flows to shareholder returns. It currently prefers increasing its base dividend as a means to distribute the excess cash.
It raised its regular annual dividends by a massive 32% to $0.58 per share early this year. This implies a dividend yield of 6%, higher than many Canadian energy bigwigs. Moreover, the base dividend increase indicates management’s confidence in its future earnings growth and balance sheet strength.
Interestingly, the company aims to increase its shareholder dividend further to $0.73 per share by the end of 2023. It will raise payouts to those levels once it achieves the net debt target.
Bottom line
WCP stock has returned 15% in the last 12 months and 770% in the last three years. After such a massive move, it is trading four times its earnings and seven times 2023 free cash flows. This makes it an appealing bet from a valuation standpoint and indicates handsome growth prospects. Its solid drilling inventory and supportive price environment could drive handsome free cash flow growth. An improving balance sheet and growing dividends also make it attractive among peers.
