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BMO's veteran oil & gas stock analyst calls out 'glaring disconnect' in market

Oil and gas stocks have handily outperformed the broader Canadian market in 2024. (THE CANADIAN PRESS/Jeff McIntosh)
Oil and gas stocks have handily outperformed the broader Canadian market in 2024. (THE CANADIAN PRESS/Jeff McIntosh) (The Canadian Press)

Investors are foolishly snubbing oil and gas stocks, according to a veteran equity analyst, calling out a “glaring disconnect” he sees between their healthy profits and discounted shares.

The iShares S&P/TSX Capped Energy Index ETF (XEG.TO), a basket of Canadian large-cap oil and gas companies like Suncor Energy (SU.TO)(SU) and Canadian Natural Resources (CNQ.TO)(CNQ), has climbed about 17 per cent year-to-date, handily outperforming the broader Canadian market. That strength has come in what’s been a sluggish year for financial stocks, the other heavyweight component of Canada’s main index.

“The North American oil and gas group has delivered relatively strong performance over the last several years, and is now poised to deliver attractive cash returns to investors,” BMO Capital Markets analyst Randy Ollenberger wrote in a recent note to clients. “Despite this, the sector remains under owned and underappreciated.”

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Ollenberger has said this before. In April, he called the newly expanded Trans Mountain oil pipeline, and the Shell-led LNG export terminal nearing completion on the B.C. coast, “very, very bullish” for the sector, adding investors seem to have little regard for this.

On top of that, he says North American oil and gas companies tend to offer higher profit growth and free cash flow yield, while returning more capital to shareholders.

“Despite these attributes, the group continues to trade at a significant discount to other investment sectors in the market,” Ollenberger wrote. “The most glaring disconnect is on free cash flow.”

He expects the large-cap oil and gas group to generate an average free cash flow yield of about 10 per cent in 2025, and around 12.5 per cent in 2026.

“These are materially higher than the overall market,” Ollenberger added.

His top picks include ARC Resources (ARX.TO), Canadian Natural Resources, Cenovus Energy (CVE.TO)(CVE), Chevron (CVX), Chord Energy (CHRD), EQT (EQT), MEG Energy (MEG.TO), NuVista Energy (NVA.TO), Topaz Energy (TPZ.TO), Veren (VRN.TO), and Whitecap Resources.

PrairieSky Royalty (PSK.TO) is expected to kick off the Canadian oil and gas sector’s second-quarter earnings season after the markets close on July 15.

“We expect producers’ quarterly results to be largely drama-free,” RBC Capital Markets analyst Michael Harvey wrote in a research note last week.

Company executives should be in an optimistic mood heading into the second half of 2024, according to a report released on Tuesday by Deloitte Canada.

“The oil sector continues to benefit from strategic infrastructure projects like the Trans Mountain Expansion, which are improving market conditions and supporting production growth,” Andrew Botterill, an energy, resources, and industrials partner at Deloitte, stated in a news release.

“Despite factors like a mild winter demand and higher-than-average storage levels, the natural gas sector is poised for significant growth, driven by ongoing LNG projects and rising demand for gas-fired electricity generation in Canada,” he added.

Deloitte Canada predicts the price of U.S. benchmark West Texas Intermediate crude (CL=F) will average US$77 per barrel in 2024, and US$72 in 2025. Prices have eased since closing at a more than two-month high near US$84 last week.

“We expect crude oil prices to remain relatively range-bound over the balance of the year amid tepid demand growth,” Ollenberger wrote. “In 2025, the supply-demand balance could start to tighten, which would allow OPEC to begin unwinding some of its voluntary production cuts, and set the stage for stronger crude oil prices.”

Jeff Lagerquist is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jefflagerquist.

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