Canadian energy stocks on sale

Invesco's Norman MacDonald hunts for the next Nexen.

Sonita Horvitch 8 August, 2012 | 6:00PM

Norman MacDonald, a vice-president and portfolio manager at Invesco Canada Ltd. who specializes in resource stocks, has used the recent high-profile takeover bids for two Canadian energy companies to realize significant wins for his funds.

"The Canadian energy sector has been weak for some two years," he says. The stock market has "excessively discounted the value of the companies despite their good-quality energy reserves."

This is attracting takeover bids by other energy companies, says MacDonald, who is a value manager responsible for Trimark Resources and Trimark Energy Class.

In June and July, leading Asian government-backed oil and gas giants "stepped up their shopping" for Canadian energy companies. "This reinforces my thesis that many of these companies are on sale," MacDonald says.

On June 28, Petronas, the Malaysian national oil and gas company, made its initial offer for Canada's Progress Resources Corp. PRQ of $20.45 a share or a 77% premium over Progress's share price of $11.55 on June 27. On July 27, Petronas raised its bid for Progress to $22 a share in the face of a competing bid.

On July 23, CNOOC Ltd, the Chinese government-backed major global energy producer, announced its bid for Canada's Nexen Inc. NXY at US$27.50 a share, representing a 61% premium on Nexen's common shares on the New York Stock Exchange NXY on July 20. Progress and Nexen have featured prominently among Trimark Resources' top 10 holdings for some time.

At June 29, Trimark Resources had 7% of the fund in Progress Resources. The company has a dominant position on Canada's Montney shale-gas play, an ongoing investment focus of MacDonald's. "Progress's stock was depressed because of the weak natural gas price; the market missed the value and scale of the land it has accumulated."

Nexen, with its Canadian and international interests, was the second largest holding in the fund at 5.4%. Nexen, he says, "has suffered from some management and operational challenges, but I am a patient investor."

 
Norman MacDonald

MacDonald sold his holding in Progress shortly after the initial bid for the company, and in Nexen after the July bid. "The takeover prices represented huge premiums for the investor and provided me with the funds to go after other companies that were still bargains."

Using part of the proceeds of the two sales, MacDonald has substantially increased his holdings in a number of energy and some materials stocks. "I have some cash left over, so there is scope to cautiously deploy this in other value situations."

An oil and gas producer that is now the biggest holding in Trimark Resources is mid-cap Crew Energy Inc. CR. Some 60% of Crew's production is in natural gas and liquids and 40% is in oil.

"This stock was trading at a significant discount to my estimated intrinsic value," says MacDonald. The company's land base in Septimus, B.C., which is part of the Montney shale-gas play, is "an underappreciated asset," he notes.

Also, the company, which has "a medium-quality oil pool," had some challenges with its operations in Princess, Alta. This has held back the stock, MacDonald says. "Granted, Princess's difficulties will make Crew's production growth less predictable than it has been in the past, but the company is likely to be able to fix this problem," he says.

MacDonald continues to like Range Resources Corp. RRC, also in the top 10 holdings of Trimark Resources at June 29. "The investment case is similar to that of Progress," he says.

Range's stock is trading at a substantial discount to the company's net asset value due to the low natural-gas price. Yet, the company is "a dominant natural-gas producer in the Marcellus shale-gas play in Pennsylvania, another investment focus of mine."

Range Resources, says MacDonald is one of the largest landholders in the southwestern portion of this play, one of the largest of its kind in the world. The company is, he says, working hard to enhance the value of the liquids in the gas. For example, it will be supplying ethane, one of the liquids found in the Marcellus natural-gas field, to NOVA Chemicals Corp.'s plant in Sarnia, Ont."

Crew Energy Inc. Range Resources Corp.
Aug 7 close $7.24 $65.21
52-week high/low $14.23-$4.88 $77.24-$51.56
Market cap $875 million $10.6 billion
Total % return 1Y* -46.4% 14.4%
Total % return 3Y*  8.3% 12.3%
Total % return 5Y*  -1.0% 11.6%
*As of Aug. 7, 2012 Note: All figures for Range Resources are reported in US$ Source: Morningstar

Turning to the materials sector, MacDonald has boosted his investment in the international base-metals miner Ivanhoe Mines Ltd. IVN, using some of the cash from his recent sales.

Ivanhoe is now among the top 10 holdings of Trimark Resources. MacDonald notes that the Anglo-Australian mining giant Rio Tinto Ltd. is Ivanhoe's controlling shareholder. Ivanhoe's major asset is its "high-quality, world-class" Oyu Tolgoi copper-gold mine in Mongolia.

Ivanhoe recently made a rights issue to fund the construction of this mine and MacDonald participated in it. "This mine is expected to be in production in 2013."

Ivanhoe's stock price has languished, in part, he says, because of concerns about the slowdown in China, despite the fact that the price of copper has held up well. "The weakness in the stock created an investment opportunity."

Within the materials sector, gold stocks represent some 20% of the fund. "The gold companies as a group have turned in a dismal operational performance," MacDonald says. "The companies are battling with both rising costs of building new mines and inflating operating costs."

The three main gold holdings of Trimark Resources are Barrick Gold Corp. ABX, Torex Gold Resources Inc. TXG and Detour Gold Corp. DGC. "I am taking advantage of weak valuations on the senior producers such as Barrick to add to holdings, and also focusing on some emerging producers."

To MacDonald, the stocks of senior gold producers are historically cheap on traditional valuation metrics. "In fact, they are way too cheap to ignore."

MacDonald recently added to his holding in Barrick. The stock currently trades at "about half its historic valuation at eight times estimated earnings-per-share for 2013 and five times cash-flow-per-share estimates for next year."

Barrick, which recently reported "disappointing" second-quarter earnings, is now under a new CEO, Jamie Sokalsky. "I am comfortable," says MacDonald, "with management calling a time-out on production growth and renewing its focus on profitability."

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Sonita Horvitch

Sonita Horvitch