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Advisor Stocks A strategic approach for investing in the downtrodden oil and gas sector

‘If we’re looking from an investment perspective at a 10-year or 20-year time horizon, I believe there’s a place in portfolios for energy, but it shouldn’t remain constant. It should change with the opportunity,’ says Philip Petursson, chief investment strategist at Manulife Investment Management.

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Better days are ahead for Canadian investors who are watching their retirement savings take a drubbing from the oil and gas sector’s meltdown. But a nuanced strategy will be necessary to choose the winning plays.

That’s the message from some energy investment experts, who say oil and gas stocks remain an essential component of Canadians’ portfolios both for future growth and current income.

“Canadian oil and gas appears to be the sector investors forgot,” says Philip Petursson, chief investment strategist with Toronto-based Manulife Investment Management. “[But] there’s a place for energy in a portfolio.”

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The past few years have had many retail investors smarting. The benchmark S&P/TSX Capped Energy Index, the basket of Canadian energy stocks that are staples in most Canadians’ investment portfolios, has declined in value by about 60 per cent since September 2014 as a supply glut slashed the price of crude oil to US$55 a barrel from US$95 a barrel and plunged natural gas prices to $US2.30 per million British thermal units (mmBtu) from US$8 per mmBtu.

Energy stocks account for almost 20 per cent the S&P/TSX Composite Index, which makes them difficult to avoid for retail investors looking for Canadian stocks that pay out dividends. Most Canadian equity investment funds – the primary investment vehicles for Canadians – hold oil and natural gas weightings that reflect the broader index.

Oil and gas stocks remain key components in Manulife Investment Management’s Canadian equity funds, Mr. Petursson says, but volatility in the sector calls for a more strategic approach for investors who are saving for retirement.

“I don’t believe that, over the long-term, you just want to buy and hold energy and ignore the market signals,” he says. “If we’re looking from an investment perspective at a 10-year or 20-year time horizon, I believe there’s a place in portfolios for energy, but it shouldn’t remain constant. It should change with the opportunity.”

For example, portfolio managers at Manulife Investment Management have decreased their holdings in pipeline companies, including Enbridge Inc. (ENB-T) and Pembina Pipeline Corp. (PPL-T), as Canada struggles to find a political solution to build out its pipeline network to get oil and natural gas to the global market, Mr. Petursson says. The added cost of shipping product from Alberta to the Pacific coast by rail has lowered the price of Canadian crude to record lows compared with already depressed global prices.

“When you look at the pipelines relative to producers, the market is suggesting they perhaps have to cut their dividends and reconfigure their business a bit,” he says.

However, Mr. Petursson has been adding producers – also known as integrated companies – to his portfolios as their share prices have fallen.

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“On a price-to-book value or price-to-earnings basis, producers are trading near the cheapest levels and the widest gap to the [S&P/TSX Composite Index] in 15 years,” he says.

In addition to capital appreciation, retail investors can continue to count on the integrated companies to grow dividend payouts for well over a decade as new technology lowers production costs and widens profit margins, he says.

“We’re talking about companies that have very long-dated production. Suncor [Energy Inc. (SU-T)] and Canadian Natural Resources [Ltd. (CNQ-N)] have a 100-year reserve life,” says Petursson.

Randy Ollenberger, managing director and equity research analyst at BMO Capital Markets, has been covering the integrated companies from his Calgary office for more than 20 years and has the equivalent of “buy” ratings on Suncor, Canadian Natural Resources, Cenovus Energy Inc. (CVE-T), Arc Resources Ltd. and Tourmaline Oil Corp. (TOU-T).

Companies that both extract oil and gas from the ground and supply it to the market should continue to pump income to shareholders for a long time even without additional pipeline capacity, he says.

“If you’re thinking about them as an income vehicle, the pipeline issues are almost irrelevant because they’re not trying to grow their businesses and move more volumes,” Mr. Ollenberger says. “If you’re just talking about them maintaining their existing production and cash flow streams, then you don’t need any new pipelines.”

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Annual dividend payouts among the integrated companies vary, but are typically in the 4 to 5 per cent range, which is generous in an era of rock-bottom interest rates and fixed-income yields. Mr. Ollenberger says those dividends can grow because costs are relatively low for established Canadian oil sands producers compared with many of the shale upstarts adding to the supply glut.

“The amount of capital they have to reinvest every year just to maintain their facilities and hold production flat – and continue to generate the cash flow stream – is very low compared with everything else in the world,” he says.

Still, bigger concerns hang over the oil and gas sector as the growing popularity of electronic vehicles and alternative energy put the future of fossil fuels in question. Nevertheless, Mr. Ollenberger says fossil fuels will continue to dominate the energy market for at least 50 years.

“We are going to still need energy in some form as a society, and that’s not going to go away, whether its energy coming out of electrons into an electric vehicle or energy coming as gasoline or diesel fuel,” he says.

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