The ongoing flurry of M&A activity in the energy sector has provided a much-needed boost to depressed energy stocks.
As more foreign companies take over Canada’s energy corporations, the value of Canadian assets is rising in global markets.
The $15-billion takeover of Canada’s Nexen Inc. by the Chinese refiner CNOOC is the latest in a growing trend whereby companies from energy-hungry emerging markets are buying Canadian concerns whose balance sheets are being hammered by weak natural gas prices.
The latest deal comes close on the heels of CNOOC’s decision to acquire a 49%, $1.5-billion, stake in Talisman Energy Inc, Canada’s sixth largest oil and gas exploration company.
In another ambitious foreign transaction, Malaysian energy giant Petronas is buying Calgary-based Progress Energy Resources Corp for $5.5-billion.
Energy demand is a function of economic growth. And this explains the steady rise in trade ties between Canadian and Asian companies. The latter group is growing, fast replacing the weaker U.S. market with depleting energy needs.
There’s a big disconnect in the market between the haves and the have-nots, says Norm MacDonald, a fund manager at Trimark.
“When I first got into this business 16 years ago, natural gas was a continental game, but it’s becoming global,” he says. “In Canada and the U.S., we have the emergence of the unconventional gas supply, which has led a lot of companies and countries that don’t have those opportunities to come to the table.”
When investors from Asia take over our key energy assets, they link demand with supply. Liquefied natural gas, or LNG, is sold for under $3 per million British thermal units in low-demand North America.
In energy-starved Asia, it fetches as much as $18 per million BTUs.
If this gas is exported to Asia, that’ll drive up the value of an energy company’s stock, says MacDonald. “The goal at the end of the day is to get some of this gas out of the country via LNG.”
And that’s why companies like CNOOC will pay $27.50 per common share of Nexen, which translates to a 61% premium over the closing price on the day of the deal.
This is just the tip of the iceberg. Canada’s emergence as an aspiring energy superpower will continue to attract more foreign suitors for its local assets. Potential investment opportunity will soon follow.
Those watching the market closely are busy identifying the next takeover target in which to invest. It always starts with the management team and the quality of the assets.
“People should be looking for companies that have the scale, are well managed and have a flexible balance sheet,” says MacDonald. “When everyone started making these unconventional plays a while ago, gas was $5. You have to have the [ability] to survive if gas dips below $2 like we just saw.”
These are companies with beefed up balance sheets. Range Resources and Ultra Petroleum in the U.S., and Crew Energy in Canada, are three energy companies that may be flying under investor radar, but get the most ticks on MacDonald’s due-diligence checklist.
There’s another way to play the energy market: investing in satellite sectors closely linked to energy production. This could be achieved, for instance, by investing in companies that make equipment for natural gas compression, essential to the transportation and production of natural gas.
“Compression is going to be a big deal,” says MacDonald. “A specific niche investment that we do have is the compression equipment side of the business. Our firm owns a lot of Enerflex [a supplier for natural gas compression and oil and gas processing].”
What investors must bear in mind, though, is that energy stocks are a patient investment.
“These are not momentum stocks,” says MacDonald. “It took us 2.5 years on Progress [Energy] to realize the value; so they are buy and hold.”