Canopy Growth Corp. (TSX:WEED) is now down nearly 60% off the peak established in late 2016. The recent pullback has certainly taken a large degree of risk out of the stock by deflating what was a truly absurd valuation. While the pullback represents the best entry point in months (and may very well represent a short-term bottom), investors should understand that Canopy’s valuation is still extreme, and there are still many factors standing in the way of Canopy actually justifying its valuation.

While Canopy is currently a top-tier name in the cannabis space, as evidenced by its ability to maintain a nearly 55% market share (looking at its last quarter earnings as a percentage of total sector revenues), many of its risks are outside its control.

Valuation is still extreme, even after the recent pullback

Canopy currently has trailing 12-month revenue of $30 million, giving it a trailing price-to-revenue ratio of 44. Using consensus forward revenue estimates, Canopy is expected to earn $140 million of revenue in 2018 — an impressive 366% growth, and the reason for the company’s lofty valuation. This gives the company what seems like a more reasonable valuation at 9.43 times 2018 revenue.

This is, however, extreme by almost every measure. Tesla Inc. (NASDAQ:TSLA), seen as one of North America’s most overvalued names, trades at 2.75 times 2018 revenue. Of course, some may say that Tesla, operating in the relatively slow-growing automobile market, is not a valid comparison.

A more useful comparison may be technology names in the late 1990s before the tech bubble burst. These are names that benefited from the largest speculative bubble in recent history, and the vast majority do not exist anymore. Pets.com, for example, traded at 23 times trailing 12-month revenue (compared to Canopy’s 44). Theglobe.com traded at 25 time trailing 12-month revenue, and etoys.com traded at 54.

Some investors may say that using backward-looking revenues like the above example isn’t useful, but even on a forward basis, Canopy’s valuation of nine times forward revenue has little comparison.

Canopy will face increased competition

Right now, Canopy has three major competitors, and there are 42 companies that are licensed by Health Canada to produce marijuana for medical purposes. Health Canada, however, recently stated that it is in the process of rapidly approving new producers. The government wants to ensure there is enough legal marijuana supply to meet demand and also wants to ensure there is a good mix of large and small producers.

This means that Canopy, which currently enjoys a fairly small market, will face a market that is growing in size. In addition, current projections show that by 2020, marijuana demand in Canada is set to exceed supply, and the current pipeline of supply set to come online is inadequate. This will put upward pressure on prices, which will lead to companies like Canopy either losing recreational market share to the black market or pricing coming down.

This could put pressure on long-term growth prospects for Canopy — something Canopy cannot afford at all given its extreme valuation.

The post These 2 Factors Could Ruin Your Investment in Canopy Growth Corp. appeared first on The Motley Fool Canada.

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The Organization of Petroleum Exporting Countries (OPEC) met once again on May 25 in a highly anticipated meeting that was widely expected to determine the course of oil prices for the rest of 2017 and into 2018. After the meeting concluded, oil prices proceeded to plunge nearly 5%, as the market was largely unimpressed with the agreement OPEC produced.

OPEC agreed to extend the 1.2 million bpd production cut agreed on in November 2016 for additional nine months (the agreement spanned the first six months of 2017). It is important to remember that only a few months ago, the market was uncertain if OPEC would even extend the agreement for another six months.

As the meeting approached, however, it became clear through a series of statements that not only would the market get a six-month extension, but there was strong support for a nine-month extension. Oil rallied, and this rally was extended by rumours that OPEC was planning on deepening the cuts past the 1.2 million bpd determined in November.

With a nine-month cut priced in, and the market eagerly anticipating an additional surprise, the market sold off sharply on the news that an agreement has been reached, despite the fact only a few months ago, such an agreement would have been considered tremendously bullish.

Regardless of the market’s short-term view on the agreement, the impact over the next several months on oil-leveraged names like Baytex Energy Corp. (TSX:BTE)(NYSE:BTE) will be tremendously bullish.

Imports to the United States should drop sharply

Oil’s weak performance lately is due to several factors, but a key factor is that U.S. crude inventories — sitting at 516 million barrels — are 107 million barrels above the five-year average. The market has been skeptical of OPEC because even though the production-cut agreement has been in place for five months, U.S. crude inventories are barely off the all-time high of 535 million barrels set at the end of March this year.

This means that for the first three full months of the agreement, U.S. inventories actually rose steadily. Does this mean OPEC was cheating?  It doesn’t, because OPEC compliance with the deal was excellent. According to the Secondary Sources table of OPEC’s monthly report for April, production for OPEC, excluding Libya and Nigeria (which were exempt from the deal), was 29.6 million barrels per day. This is down 1.56 million barrels per day from October 2016, well exceeding the target 1.2 million barrels per day.

The reason U.S. inventories have not fallen is because key OPEC producers — like Saudi Arabia — cut production, but did not cut exports. They instead drew down their own inventories to keep revenue coming in. With inventories depleted and Saudi Arabia entering its high-demand summer season, OPEC will have no choice but to cut exports.

OPEC recently acknowledged this, and Saudi Arabia’s energy minister stated that exports to the U.S. would drop “measurably.” Saudi Arabia knows it can’t support the oil market with just words anymore, and the only way to improve prices is to cut inventories in the United States.

This means investors should see oil prices rising over the coming weeks and months (especially since U.S. storage usually draws down at this time of year).

Baytex Energy Corp. will benefit

Baytex is potentially Canada’s most leveraged oil producer. If oil rallies, Baytex is almost certain to rally to an exaggerated degree. The stock is down 43% off December highs, and it may be a smart seasonal play. With oil inventories seasonally declining until the end of October, Baytex will have an enormous tailwind, reducing risk and increasing potential reward.

The post Why OPEC’s Latest Deal Virtually Guarantees a Rally in Baytex Energy Corp. appeared first on The Motley Fool Canada.

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Canopy Growth Corp. (TSX:WEED) has quickly grown from a relatively obscure producer in a small industry to one of only two marijuana companies in the world with a billion-dollar-plus market capitalization. The company has rewarded early investors handsomely with 200% share price growth since early 2016 and has grown revenues from $7.7 million in the first three quarters of 2016 to $25.2 million in the first three quarters of 2017.

The stock has recently pulled back 30%, and being one of Canada’s most popular names (constantly listed as a “most popular stock” on BNN.ca), many are wondering whether or not this is a good buying opportunity.

This answer is complex. Canopy is currently trading at only $8.23 per share — down from a high of around $18 set in only November of last year. A return to those highs would mean a comfortable double, and the current analyst consensus target price on the stock is $14.20 — a 72% return.

Despite the optimism, shares are hugely expensive

By nearly every measure, Canopy shares are extremely expensive on a price-to-revenue basis. That is not to say that the company cannot maintain — or even grow — its current revenue multiple, but it does mean investors are taking on a large risk.

Over the trailing 12 months, Canopy earned $30.2 million in revenue. Based on the current market capitalization of $1.37 billion, this works out to a price-to-revenue ratio of 45. To put how extreme this number is into perspective, investors should compare it to some of North America’s most valuable names.

Tesla Inc. (NASDAQ:TSLA), for example — widely considered to be one of the of the most expensive names in North America — trades at a trailing 12 month price-to-revenue multiple of 6.07. The S&P 500 Index, which is trading at all-time highs, is currently trading at a price-to-revenue multiple of 2.08.

A stock’s value depends on its future growth, but even using Canopy’s revenue for 2017 and 2018, the stock is still extremely expensive. The company is estimated to earn $42 million in fiscal 2017 and $125 million in fiscal 2018.

While this is certainly impressive revenue growth, the current market capitalization of the stock more than bakes in this growth. Using those revenue figures, the company trades at 32 times and 10 times its 2017 and 2018 revenues, respectively. Tesla, for comparison, trades at 4.5 times and 2.72 times its 2017 and 2018 revenues, respectively.

The question is if Canopy can maintain these valuations, or if Canopy and the marijuana sector as a whole are in a bubble similar to the year 2000 tech bubble. On one hand, the potential legalization of marijuana in Canada creates a nearly unprecedented situation in which about a million kilograms of recreational marijuana demand annually will move from black market suppliers to licensed producers.

This situation can produce unprecedented valuations. On the other hand, increased competition, regulations, and changing investor sentiment can all bring valuations back down to earth.

What to buy instead

If you’re looking for a more reasonable valuation in the marijuana space, Aurora Cannabis Inc. (TSXV:ACB) is a better bet. Aurora has a similar revenue growth profile at a cheaper valuation. The company is projected to earn $25 million in fiscal 2017 and $125 million in fiscal 2018 (the same as Canopy).

This is despite the fact that the current market capitalization for Aurora is only $832 million, giving it a 2018 price-to-revenue multiple of six. This is still expensive, but it’s reasonable compared to Canopy. Aurora currently lacks the production capacity Canopy has (which may explain the discount), but this is set to improve as its Aurora Sky production facility comes online.

The post Canopy Growth Corp. Is Overvalued: Here’s What to Buy Instead appeared first on The Motley Fool Canada.

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On the surface, the reasoning for not having energy exposure in your portfolio seems clear. Oil prices are down over 11% year-to-date, and the energy sector is down 6.3%. This is the worst performance of the TSX’s 11 sectors.

With some sectors — like technology (up 12%), discretionary (up 12%), or even the overall S&P TSX Index (up 1.7%) — delivering solid returns, there seems little reason to invest in what looks like a failing sector.

It is important to note, however, that when the consensus is so strongly against a sector, the biggest opportunities emerge. Should oil prices strengthen, there is the potential for sector rotation to occur away from the sectors where all the money is currently parked and into energy, which will be seen as a relative value play.

Investors don’t need to look far to see an example of this occurring; last year, oil sentiment hit rock bottom in February before investors flocked back into the sector in droves.

What is holding investors back? It likely has to do with these three reasons.

Concerns over oil demand

The oil market is expected to be in deficit by over one million barrels per day in the second half of 2017, according to Bank of Nova Scotia. Goldman Sachs sees potential deficits as wide as two million barrels per day this summer.

This all hinges on strong demand growth, however. So far this year, demand growth has been fairly weak, and it has investors concerned. The International Energy Agency sees demand growing by 1.3 million bpd in 2017, but for Q1, demand growth is only expected to be about 1.1 million bpd. This is a very weak number, but it is set to improve.

Demand in the second half of the year is almost always stronger. In fact, according to GMP First Energy, since 1991 there have only been four years where demand was weaker in the second half. This is due to summer driving season and the fact that refineries do most of their maintenance shutdowns in the first half of the year.

This year’s maintenance shutdowns have been much larger than usual, which has also impacted demand. Currently, this year’s refinery maintenance season has been the largest in four years in terms of capacity offline and has also been much longer than usual. As refineries come back online (they should be online by the end of the month), demand is set to return.

U.S. production is growing

Investors are also concerned of the fact that U.S. shale production is growing steadily (it has grown from 8.9 million bpd to 9.3 million bpd so far in 2017). Some expect it to grow to 9.8 million bpd or even 10 million bpd by year end.

This much production coming online could overwhelm demand and send prices down. While this is certainly a concern, it is important to remember that U.S. shale is only 5% of global supply. It is important to look at the other 95% of global supply, which has been hit by three consecutive years of declining capital spending.

Global production naturally declines by about 3% annually, and capital is required to offset these declines. Three years of weak prices have resulted in most global production not having adequate capital to offset production declines and add to reserves to enable future production.

In addition, there are short-term limits to U.S. production growth that will keep U.S. production in check this year. Oil servicing costs are expected to grow by as much as 20% this year (the costs to drill, pump, etc.), and this will eat into available capital.

OPEC not adhering to agreed-upon cuts

OPEC agreed last fall to cut production by 1.2 million barrels per day (and is expected to extend these cuts this month). While many worry about OPEC cheating, the fact is that OPEC compliance has been excellent. In February, OPEC complied 90% to the cuts, and 104% in March. With OPEC having incentive to extend these cuts, the outlook for oil is bright.

Investors should look to play bullishness in oil with a diverse set of names. A pressure-pumping stock like Trican Well Service Ltd. (TSX:TCW) provides exposure to the growing oil production, and a name like Baytex Energy Corp. (TSX:BTE)(NYSE:BTE) provides exposure to the U.S. and improving oil prices.

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While the Toronto Stock Exchange is only about 2% off all-time highs after a monster multi-year rally, shareholders of Cenovus Energy Inc. (TSX:CVE)(NYSE:CVE) certainly hasn’t participated — the stock recently closed just above $13 per share, which is only slightly off the all-time low of about $12.60 set in February 2016 at the very bottom of the historic collapse in oil prices.

For value investors, this sell-off represents tremendous opportunity with very minimal downside and huge upside. It is a clear example of a market overreacting.

Cenovus is trading near the same level that it was trading at in February 2016, when oil prices were $25 per barrel. Today, oil prices are $45 per barrel, and Cenovus is projected to earn about $2.68 per share of cash flow for 2017 (assuming a conservative oil price of $53.25 per barrel for the year). This compares to $1.71 per share in 2016, and $2.07 cents in 2015.

Cenovus shares are currently pricing in extremely low oil prices for the year, which is not realistic given that oil inventories have been declining since July 2016, and the IEA states the market is currently close to balance. For the second half of the year, crude should see a deficit of at least one million bpd.

Cenovus is also being punished relative to its peers. Until recently, Cenovus traded at a premium to its peer group, and it now trades at a large discount (5.5 times 2018 EV/DACF compared to its peers at 6.8 times).

Is this discount justified?

Cenovus’s huge underperformance can be linked to its recent $17.7 billion acquisition of oil sands and conventional oil assets from ConocoPhillips. The transaction sees Cenovus purchasing the remaining 50% interest in its oil sands assets (Cenovus shared these assets with ConocoPhillips) as well as acquiring conventional oil assets in the Deep Basin region, which will be a new growth play for Cenovus.

Investors may be curious as to why Cenovus shares sold off heavily after the acquisition, given the fact that Canadian Natural Resources just made a similar oil sands acquisition from a large U.S. player, and shares jumped 10%.

The poor reaction to Cenovus’s acquisition occurred for two reasons: investors are concerned with the price, and investors are concerned that Cenovus is acquiring Deep Basin conventional oil assets. This is an area where Cenovus has no experience, which means the execution risk there is high. Investors also see the assets as outside Cenovus’s core area of expertise.

Starting with the price, while the deal certainly was expensive, it adds value if investors assume a higher oil price going forward. Currently, the futures strip for oil prices sees oil prices under US$50 until 2020. If the market is valuing the deal using these prices, Cenovus certainly overpaid.

According to one report, using strip pricing, the assets Cenovus acquired are worth about $12.72 billion compared to the $17.7 billion Cenovus paid. However, using a more optimistic outlook ($72 per barrel average oil prices between 2018 and 2022), the assets would be worth $21.2 billion.

While this may seem optimistic, GMP First Energy predicts $75 per barrel by the end of the decade because U.S. tight oil (which is only 5% of global production) simply cannot meet growing demand, and other sources will be needed. These sources, however, have been tremendously underinvested in over the past few years.

Cenovus claims it paid $55 or $60 per barrel for the deal, which means the deal is economic at these prices.

Investors are also worried about Cenovus’s balance sheet relating to the deal; the deal saw Cenovus’s debt to cash flow growing from 0.7 to three in 2018. Cenovus, however, has an active plan to reduce this through selling off poorer-quality assets, and if Cenovus succeeds in its full asset-sale plan, debt to cash flow will fall to 2.7 in 2018.

A low-risk buy  

Overall, the deal will see free cash flow double over time, according to Bank of Nova Scotia, and the market is assuming unreasonably low long-term oil prices. Cenovus will outperform in a larger oil price recovery with little downside remaining after the massive sell-off.

The post Cenovus Energy Inc. Is Trading at All-Time Lows: Huge Upside Ahead appeared first on The Motley Fool Canada.

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With regards to the recent plunge in oil prices potentially being the bottom for 2017, it could not be better stated than how Ed Morse, head of commodities research at Citigroup, put it in a recent interview: “The market really is fundamentally tightening up; it is never possible to call a bottom, but I suspect this is a great buying opportunity before a big jump in prices by the end of the year.”

Morse has the right idea, and to understand why, it is important to understand why crude plunged nearly 6% in a single day (before rebounding) and what is going to happen in both the short and medium term.

It is important to note that while oil may have dropped nearly 7% in the past week alone, there was little, fundamentally (in terms of actual changes in the supply/demand/inventory outlook), that justified the sell-off and extreme pessimism. Just how pessimistic is the oil market? Many top-tier Canadian producers are currently trading at the same levels they were last year when oil was under US$30 per barrel.

The only real “fundamental” news from the oil market this week was an inventory report that was fairly neutral, and news that a Libyan oil field resumed production. The inventory report showed crude stockpiles in the U.S. fell by 930,000 barrels (smaller than the market expected, but this figure would have been under two million if it weren’t for crude from the U.S. strategic petroleum reserve being released). It also showed that total petroleum product stocks in the U.S. fell year over year (a significant positive milestone).

There were also some concerns over demand from China, but oil demand is still expected to be impressive this year (1.6 million bpd, which is 60% higher than the 10-year average). None of this seems to justify the massive plunge in crude, and as analysts from Goldman Sachs recently stated, the move was due to technicals, not fundamentals.

In other words, crude plunged below its key 200-day moving average, as well as below a major price trend-line, and this resulted in many large hedge funds being forced to sell to adhere to their risk-management policy.

What does this mean going forward?

Investors would be wise not to let the recent price action trick them into thinking oil fundamentals going forward are horrible. As Ed Morse stated, the market is tightening and has been since July 2016, when U.S. total petroleum inventories and OECD global inventories started declining.

The market is currently waiting for U.S. crude inventories (which make up total U.S. petroleum inventories and are near all-time highs) to decline substantially before bidding up oil prices. U.S. crude inventories have now fallen several weeks in a row, and this is set to accelerate.

Typically, crude inventories rise at this time of year, and the fact they have been falling is bullish. In fact, looking at the 10-year median, crude oil stocks do not typically start to decline until the end of May, which coincides with the start of driving season.

This should lead to much larger draws in inventories, and a much more bullish outlook on oil prices (especially if OPEC agrees to extend their production-cut agreement, which is widely expected).

Over the longer term, should demand hold up, several years of major underinvestment due to the oil price crash should lead to supply issues and should support prices.

Baytex is one way to play the rebound

Baytex Energy Corp. (TSX:BTE)(NYSE:BTE) is extremely leveraged to oil prices, meaning should oil recover, it has significant room to outperform. It also means investors can take a much smaller position.

About half of Baytex’s production is in the highly economic Eagle Ford play in the U.S., and Baytex is adding rigs in this area. The stock currently trades at a 25% discount to its peers, according to Bank of Nova Scotia, giving it plenty of upside potential in the event of an oil recovery.

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Regardless of your personal view on the outlook for oil prices, the massive underperformance of the sector has left a range of names down 20-50% from where they were just a few short months ago. Energy is now the worst-performing sector in the U.S. (down 10% year-to-date) and one of two sectors that are in the red for the year.

The important question is, has the long-term outlook for energy names really worsened by 20-50% since January, as prices would suggest, or is the market making a key error in valuing these names? Oil is currently trading at about $49 per barrel compared to around $53 at the start of the year, and it is difficult to see how a 7.5% sell-off in oil prices justifies a 50% sell-off in some key high-quality Canadian names.

Some of these stocks are trading at the same levels they were last year when oil was in the low US$30s. This weakness implies that energy names are pricing in a nightmare scenario for crude, when in reality the picture is much brighter than many suggest.

The key catalyst for higher oil prices will be the continued draw-down in U.S. petroleum storage (which began in July 2016 and coincides with global storage levels that have been declining over the same period), and the following energy names have tremendous upside of this continues and minimal downside if it doesn’t.

Cenovus Energy Ltd. (TSX:CVE)(NYSE:CVE)

Cenovus is probably the poster child for weakness in the energy sector. Currently, Cenovus is down a massive 37% year-to-date (a significant move for a large-cap oil name). In fact, at the current price of $13.50 per share, Cenovus is trading at the same level it was on February 10, 2017, when oil prices were US$27 per barrel.

This level of undervaluation is extreme. The main reason for the weakness in Cenovus (besides the broader sell-off in the energy space and in oil prices) is its recent $17.7 billion acquisition of oil sands and natural gas assets in Canada from ConocoPhillips.

The acquisition sees Cenovus gain 100% working interest in its Christina Lake, Foster Creek, and Narrows Lake oil sands assets and acquire a new core area in Deep Basin. What’s the problem? The deal is seen as expensive and damaged Cenovus’s pristine balance sheet.

The deal sees debt-to-cash flow climb from 0.7 times cash flow in 2018 to three times cash flow. In addition, using strip oil prices (which basically sees US$50 oil out to 2020), these assets are only worth about $12.7 billion, which means Cenovus overpaid.

The deal, however, will double Cenovus’s free cash flow (partly due to the fact Cenovus is acquiring low-cost Deep Basin assets and will be selling higher-cost conventional assets), and assuming an even slightly more bullish oil price forecast (US$55-60 per barrel), the deal makes great sense.

Should Cenovus simply trade in line with its peer group in terms of EV/DACF in 2018, it would trade at around $20 per share — 48% above today’s levels.

Trican Well Service Ltd. (TSX:TCW)

Trican is a smart way for investors to play the forecasted rise in production coming out of Canada. Trican is an oilfield service provider which offers hydraulic fracturing, among other things, and rising production is good news for Trican shares.

This year is expected to see a massive 60% growth year over year in Canada, and Q1 2017 saw 78% year-over-year growth in drilling activity. Trican recently merged with Canyon Services to create the largest driller in Canada (37% of all frac capacity), and the merger will create major synergies.

In addition, the merger will give the combined company a market capitalization of over $1 billion, which will put it on the radar of large funds. Bank of Nova Scotia sees $7 per share for Trican — 90% above today’s levels.

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West Texas Intermediate crude oil is down nearly 10% from the recent high of nearly US$54 per barrel set in early April, and oil bulls are, once again, losing hope. As a result, it’s no surprise that the energy sector as a whole (which includes both producers and pipelines) is sharply underperforming nearly every other sector in the United States and Canada.

This also means that for value investors, there is no better place to be. Just how badly is the energy sector doing? In Canada, the overall energy sector is down 5.7% year-to-date. This compares to the 2.4% positive gain the TSX saw. It is the only sector (other than health care) which is in the negative for the year, and the 5.7% loss for the energy sector is actually under exaggerated due to the fact that pipelines are only down 1.7%. Canadian producers are down 11% year-to-date.

The same story is true south of the border, where energy is down 9.1% for the year and is the only sector in the red. The recent under performance is the result of hedge funds and generalist investors fleeing the space due to the recent softness in the price of oil, and the generally bearish narrative that’s been surrounding the market. This under performance also means that there are plenty of investors sitting on the sidelines ready to move cash into the sector at the first sign of oil price strength.

This effect could be amplified by the fact that most other sectors have been performing well and are perceived as being overvalued. However, for this to happen, oil prices will need to improve, and so will the narrative around oil. Here’s why this will happen sooner than many think.

Investors are focused on U.S. oil inventories

The recent bearish sentiment around oil has everything to do with U.S. crude inventories and, to a lesser extent, rising U.S. production levels. U.S. crude inventories are just slightly off all-time highs and well above the five-year average. With oil inventories in the U.S. at all-time highs, why would oil be set to rally? There is much more to the oil market than just U.S. crude oil inventories, and U.S. inventories are imminently set to fall (and, in fact, have fallen for the past few weeks).

For example, total U.S. petroleum stocks, which includes gasoline and distillates along with crude oil, have been declining steadily since July 2016 (except for a brief spike early this year due to a surge in OPEC imports); they’re currently at the same levels they were last year at this time.

Outside the U.S., the picture is much more bullish. In the past three months alone, oil inventories globally have fallen by over 70 million barrels (which is around 25% of the total oversupply), and these inventories have been steadily declining since July 2016.

These declines in inventory began even before OPEC announced their recent cuts. Oil companies globally experienced declining production on an annual basis, and oil prices have not been high enough to generate the capital needed to grow production.

This trend will continue, and while U.S. production will continue to grow, production declines from outside the U.S. and OPEC will offset this growth and lead to under supply as the International Energy Agency sees for the remainder of the year.

In the short term, U.S. refineries coming back from maintenance, strong seasonal gasoline demand, and a potential renewal of OPEC’s cuts should lead to higher prices in the coming months.

Baytex is a good way to play upside

Baytex Energy Corp. (TSX:BTE)(NYSE:BTE) is unique because 51% of its production comes from the United States. This makes it immune to many of the worries of a border adjustment tax from the Trump administration. In addition, Baytex has been one of the poorest-performing Canadian names over the past few months and will respond much stronger than its peers when oil rallies.

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The oil market has shown massive volatility over the past month, and investors have been subject to constantly fluctuating headlines on the outlook for the oil market — from being massively bullish early in the month as oil was rallying to bearish now as oil is declining.

Investors can profit immensely in this environment by ignoring the constant slew of news and frequently changing sentiment around the oil market. Instead, focus only on the fundamental picture for oil. Unlike the manic headlines that focus on the latest OPEC rumour, the weekly EIA storage report, or the latest U.S. rig count, the trend for oil fundamentals has been one of gradual, steady improvement.

Analysts at Goldman Sachs agree; Goldman analysts stated in a recent note that the fundamentals do not justify the recent 6% plunge in oil prices, and they forecast oil approaching $60 in the second half of 2017.

Why the recent sell-off is unwarranted

What caused the recent sell-off in oil prices? Many attribute the sell-off the EIA oil storage report that was released on Wednesday. The report showed that crude storage declined by around one million barrels (the market was expecting more), and gasoline inventories grew for the first time since February.

U.S. crude inventories recently hit a record high (they have fallen, however, for the past two weeks), which has discouraged many investors, but the broader trend is that total petroleum inventories both in the United States and globally have been in a steady, predictable decline. Total petroleum inventories include everything from crude to gasoline to distillates, and total U.S. stockpiles actually fell by 1.7 million barrels in the latest report.

In fact, last week was the first time that total stockpiles fell into a year-over-year deficit. This means that total stockpiles are less than they were during the same week last year, and it has been years since this happened. Overall U.S. inventories have actually been in a steady decline since July 2016 after building constantly since November 2013.

It is not just U.S. inventories that are declining — total OECD nation inventories, excluding the United States, have also been in a steady decline since July 2016. While the market seems to focus heavily on the U.S., 73% of the decline in OECD inventories comes from outside the U.S.

The reality is that while the market is focused on the short term, the long-term trend is positive. Currently, the IEA sees global market being roughly in balance (supply meeting demand) and falling into a deficit in the second half of the year.

Going forward, U.S. storage draws should continue, as refinery maintenance season in the United States is now coming to an end. This means refineries will be back online to purchase more crude.

Stocks to position yourself for the upside

It is a good idea to have a well-balanced oil portfolio including large senior producers, smaller produces, and undervalued names. Cenovus Energy Inc. (TSX:CVE)(NYSE:CVE) is one of those undervalued names. Cenovus recently announced it was buying oil sands assets from Conoco Phillips for $17 billion. The stock intensely sold off after investors became concerned over the massive hit to the balance sheet that Cenovus incurred to make the acquisition.

As a result, Cenovus shares are now trading close to where they were last February when oil was trading under US$30 per barrel. Cenovus’s latest acquisition will flourish if oil prices improve, and investors can buy it now for cheap.

Canadian Natural Resources Limited (TSX:CNQ)(NYSE:CNQ) is a high-quality name that should be a key part of a balanced portfolio. Like Cenovus, Canadian Natural also made a recent acquisition, but this acquisition was praised by the market due to the massive discount Canadian Natural paid for the oil sands assets it purchased ($20 billion in assets for $12.7 billion), and the massive production growth and cash flow growth boost it will provide for the company over the next several years.

The post Why You Should Be Aggressively Buying the Latest Dip in Oil Prices appeared first on The Motley Fool Canada.

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Canadian Natural Resources Limited (TSX:CNQ)(NYSE:CNQ) is seen by most investors as the premier large producer, and the share performance is a testament to this — out of 41 Canadian oil names, Canadian Natural is the third best-performing name over the past three months.

The past three months have seen a massive sell-off in Canadian oil stocks with around of a quarter of Canadian names down over 25%. The three-month period has also seen oil prices plunge below US$50 once again. Despite nearly every headwind possible for the sector (falling prices, fears of a border adjustment tax, rotation out of Canadian oil stocks to stronger-performing sectors), Canadian Natural is one of the few names to break even in terms of price performance during the period.

There are many signs that that the worst is now over for Canadian oil stocks, and Canadian Natural is poised to ride changing sentiment and improving oil prices.

CNQ’s recent acquisition will boost production to over one million bpd

Part of the reason Canadian Natural shares have outperformed as of late is due to the company’s $12.7 billion acquisition of a 70% in Shell and Marathon’s Albian Oil Sands assets. This acquisition is being widely applauded by analysts, not only for the massive discount paid, but also for the excellent strategic fit.

Canadian Natural will be receiving interest in two oil sands mines as well as an upgrader; these two mines will contribute an additional 218,000 bpd of production, which will push Canadian Natural’s total production to over one million bpd in 2017. The presence of an upgrader is also valuable since it largely produces synthetic crude oil, which is sold at a large premium to the heavy blended oil that oil sands assets would typically produce.

Canadian Natural was also able to purchase these assets at a major discount, which means that the acquisition will add about 17% to Canadian Natural’s 2018 cash flow, assuming $60 oil. The assets were estimated to cost about $20 billion, and Canadian Natural purchased them for only $12.7 billion. This worked out to about $58,000 per barrel per day of production, which is a 40% discount to what Canadian Natural paid for its Horizon mine.

This discount was obtained because that many U.S. corporations are looking to exit the oil sands. Canadian Natural, however, will acquire assets that see no production declines for 40 years and have significant synergies with its other oil sands assets. This means less sustaining capital expenditures for more production, which means more free cash flow.

An expanding free cash flow will allow Canadian Natural to de-leverage, pay dividends, buy back shares, and grow production further, and as oil prices rise Canadian Natural will see its free cash flow grow from $500 million in 2016 to over $5 billion in 2018 with $60 oil.

Sentiment around heavy oil and Canadian producers will improve

While Canadian Natural is now expanding solid production growth (800,000 bpd in 2016 to 1.2 million bpd in 2020) and expanding free cash flow, investors are still fairly negative on Canadian oil producers and Canadian heavy oil producers in general.

Canadian Natural sees about 32% of its production sold as heavy oil, and U.S. investors see Canadian heavy oil prices plunging if the Trump Administration implements a border adjustment tax. It is important to note, however, that U.S. refiners need Canadian heavy oil, since the U.S. only produces 400,000 bpd of heavy oil. In other words, border tax or not, Canadian imports of heavy oil to the United States will continue.

Once uncertainty over a border tax lessens, U.S. investors should continue to gain interest in Canadian Natural once again.

The post A Perfect Storm Is Coming for Canadian Natural Resources Limited appeared first on The Motley Fool Canada.

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