When it comes to natural resources, the Canadian market is still home to some of the continent’s top stock picks, according to Barclays.
While the oil patch is still operating under mandatory production curtailments, and there is no resolution in sight to the pipeline dilemma, the Canadian energy sector is undoubtedly in a much better place than it was a few months ago.
The pipeline bottleneck has eased and the discount on Canadian crude has gone back to normal levels.
Valuations, on the other hand, are stuck in the doldrums. Cenovus Energy Inc.’s stock, for example, trades at about a 40-per-cent discount to net asset value, Barclays analyst Paul Cheng said in a report.
“We think investors’ risk-reward view on Cenovus continues to be overly skewed to the downside,” Mr. Cheng wrote.
That’s one reason Mr. Cheng named Cenovus as the top pick among North American integrated oil companies.
It ranks among Barclays’s best investment ideas as chosen by the bank’s individual equity analysts. “The goal … is to curate the most compelling large-cap single stock ideas with superior alpha generation potential on a sector-by-sector basis," the report said.
True to form, Canada also claimed the bank’s top mining pick, with Teck Resources Ltd. The only other Canadian name on the list is Manulife Financial Corp., as the top-ranked Canadian financial-services stock. Both Teck and Manulife are carried over from Barclays’s previous picks, while Cenovus is a new addition.
We look at each of Barclays’s Canadian picks, stock by stock.
Cenovus
Most of the past five years have been unkind to Cenovus shareholders. The company suffered alongside its sector peers from a global oil glut and downturn in energy prices, which was compounded domestically by the lack of pipeline capacity that sent Canadian crude prices down to as low as US$13.46 a barrel last November.
There were also company-specific problems. The market was no fan of the debt the company incurred in a $17.7-billion deal to purchase assets from ConocoPhillips Co.
Cenovus management subsequently made an enormous bet on oil prices that backfired badly. A hedging program designed to protect against falling prices saw the company committed to selling most of its oil well below market value. A $469-million hedging loss was realized in early 2018.
Conditions have improved on all fronts.
“With the Canadian macro environment taking a complete 180-degree turn, and steep hedging losses in the rearview mirror, we think Cenovus’s cash flow outlook has improved significantly,” Mr. Cheng said.
“Even assuming Western Canadian Select crude oil differentials re-widen …, we still expect Cenovus to generate meaningful free cash flow in the years to come.”
Teck Resources
With base-metals prices in a downtrend for most of the past decade, the mining sector has been forced to cut costs and reduce debt.
Teck is no exception, according to Barclays analyst Matthew Murphy. Despite a relatively clean balance sheet and better free cash generation, Teck shares trade at a discount to peers across several different valuation metrics, Mr. Murphy said.
The company’s free cash predominantly flows from its metallurgical coal business, which is currently benefiting from elevated prices. Meanwhile, a partnership deal to expand Teck’s Chilean copper mine is nearing completion.
“With a significantly de-levered and investment grade balance sheet, the company is well positioned to advance its key copper growth project while at the same time returning cash to shareholders,” Mr. Murphy said.
Manulife
Life insurers have been waiting a long time for higher interest rates.
With the return on invested premiums forming a key profit driver for insurance companies, the low-rate environment has seen their stocks underperform for years.
Elevated bond yields, at least compared with recent years, are lifting the group’s prospects.
“Relative to its peers, Manulife’s earnings offer the most upside potential in a rising interest rate and equity market environment,” Barclays analyst John Aiken said, adding that the company’s stock trades well below its historical peaks in valuation.
“We expect the lift in bond yields, the return of investment gains, and new cost-saving initiatives to produce double-digit core earnings growth for 2019.”