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What are we looking for?

Energy companies with takeover potential.

The screen

On Wednesday, ROB Streetwise columnist Jeffrey Jones wrote about a culmination of factors that are leading up to some potential M&A activity in Canada's energy sector. This is certainly a theme that Canadian investors should keep an eye on. This week, I revisit a strategy that I wrote about earlier in the year that looks for potential takeover targets with the following characteristics:

– Enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA) – a multiple that compares the value of a company, inclusive of debt, against the cash earnings exclusive of non-cash expenses;

– Industry-relative debt-to-equity ratio (debt to equity looks at the amount of leverage a company has taken on to finance growth. Here we've compared it with the industry average. For a takeover target, less leverage is more attractive);

– Price-to-book ratio;

– Negative price changes from month end, 12 months ago. (In this screen I've favoured stocks that have been hit the hardest, which might be viewed as attractive for potential takeovers);

Qualifying energy companies have a market cap of $400-million or more.

More about Morningstar

Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.

CPMS provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market.

What we found

I used CPMS to back-test the strategy from December, 2001, to September, 2015. During this process, 15 stocks were purchased and equally weighted. Stocks would be sold if they fell outside the top 50 per cent of the ranked universe or if they were taken over. The strategy did not beat the S&P/TSX composite over the test period (due to the nature of the factors used).

Over the history of the strategy, however, the portfolio held several names that were bought out, including Cyries Energy Inc. (merged with Iteration Energy Ltd. in 2008); Bow Valley Energy Ltd. (bought by Dana Petroleum PLC in 2009); Highpine Oil & Gas Ltd. (bought by Daylight Resources Trust in 2009); Petrolifera Petroleum Ltd. (merged with Westfire Energy Ltd. to become Long Run Exploration Ltd. in 2012); C&C Energia Ltd. (purchased by Pacific Rubiales Energy Corp., 2012); Petrominerales Ltd. (bought by Pacific Rubiales Energy in 2013); Renegade Petroleum Ltd. (bought by Spartan Energy Corp. in 2014); Talisman Energy Inc.(bought by Repsol SA in 2014); and Legacy Oil + Gas Inc. (bought by Crescent Point Energy Corp. earlier this year).

The accompanying table shows today's qualifying names.

As always, investors are advised to conduct their own independent research before purchasing shares in the companies shown.

Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.

Canadian oil takeover targets