One company that caught portfolio manager Ellen Lee’s attention in February was Calgary-based Encana. During a mid-February interview, when it was trading around $14, Lee’s view was that the company was undervalued versus its peers.
Another boon was that it had “been in the manufacturing mode [longer] than others,” meaning it had the potential to “realize productivity gains faster” and benefit from a lower cost of supply. That would help shield Encana from any oil-price volatility, said Lee, portfolio manager with Causeway Capital Management in Los Angeles, which is one manager of the Renaissance International Equity Private Pool.
Lee also likes that the company’s management “is committed to returning capital to shareholders,” she says. On Feb. 15, the company announced in a press release that it planned to repurchase up to 35 million common shares over 12 months. That normal course issuer bid, which was accepted by the TSX on Feb. 26, will cost up to $400 million.
In a Feb. 26 release, the company said that “purchasing its own shares represents an attractive opportunity that is in the best interests of the company and its shareholders.”
On March 26, Encana opened at $15.15, while other major Canadian players such as Suncor Energy, Canadian Natural Resources and Enbridge opened close to or above $40.
Deeper analysis tactics
Along with assessing how a company compares to its peers, Lee says it’s also important to analyze “where we are in the oil price cycle.” This can help shed light on how supply-and-demand trends might play out—and that’s important if you’re “trying to find companies that have specific strengths that allow them to be winners.”
But don’t come up with a forecast for oil prices that’s “prescriptively precise on where the [prices are] going. That’s a futile effort, in my view,” she adds.
One reason is the geopolitical factors that partially drive oil prices are hard to measure. “The only way to get around this issue is to be conservative so that you don’t count on geopolitical risk for oil price spikes,” says Lee.
Instead, start with fundamental analysis of supply-and-demand metrics, which includes looking at where oil supply is coming from.
“Despite the common belief that OPEC controls all of the supply, Russia plus OPEC only account for about 50% of global supply,” she says. “That means there’s another 50% of supply that’s dispersed across other regions in the world.”
She’s found oil consumption is also dispersed. It’s a “very diversified commodity from a demand perspective because half of oil consumption is in OECD countries, while the other half is in non-OECD regions,” says Lee.
Plus, outside of recessions, historical analysis shows oil demand has been relatively stable: there “hasn’t really [been] years where there was significant growth and massive volatility, except for times when there’s been a massive recession,” she adds.
Once she and her team have analyzed past trends, they can use that information to try to figure out where new supply is coming from. Findings are “typically linked to global GDP growth,” says Lee. In 2018, that new supply is coming North American shale, she says.
To come to this conclusion, she says, “[we] spent time figuring out what the marginal cost is [of this shale] and we follow[ed] companies to see if there’s been significant productivity breakthroughs or if there are cost inflation trends that are significant to the [oil price] cost curve.”
But all of these forecasts are conservative and mainly meant to provide added context, says Lee. “As a value investor, it’s not really prudent to count on a view on oil prices to make your investment thesis.”
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