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“This piece of heaven that I've found;
Rocky Mountains and black fertile ground;
Everything I need beneath that big blue sky;
It doesn't matter where I go;
This place will always be my home;
Yeah I've been Alberta Bound for all my life;
And I'll be Alberta Bound until I die.”

- Paul Brandt

For those that have experienced an Alberta winter, you may disagree with Canadian singer and song writer Paul Brandt that Alberta is a great place to be bound for in December.  In fact, our Chief Operating Officer was in Calgary a month ago on a day in which Calgary registered as the second coldest place on the planet. While he was a bit whiny about that fact, in my opinion, cold weather is like anything – if it doesn’t kill you it makes you stronger.  Last night I took my nieces and nephew on a sleigh ride in -20 degrees Celsius weather and I think it made them stronger.

I always enjoy flying back home to Alberta and into the Calgary International Airport.  Each time I’m struck by two things: the vastness of my home province and the rapid growth of Calgary, the business capital of the Canadian energy industry.  The newest addition to the growth of Calgary is a 59-story office tower called “The Bow”, which will be the largest office tower in Canada outside of Toronto when it’s completed in 2012.  This tower will become the world headquarters of Encana, a global leader in non-conventional gas production.

Alberta is the home to the vast majority of Canada’s energy resources.  In particular, the Canadian oil sands, containing ~170 billion barrels of oil reserves, is second only to Saudi Arabia and accounts for just over 13% of all global reserves.  It is estimated that the Canadian reserves could supply Canadian energy needs for the next 400 years.  This is true energy independence. 

These vast energy resources are one of the key factors supporting our long position in the Canadian Dollar (or the Loonie) in the Virtual Portfolio.  Not only is Canada completely energy independent, it will also benefit in a weak dollar environment which inflates the prices of U.S. dollar-based commodities, such as oil.  While the United States gets squeezed in a high oil price environment, Canada becomes cash rich, as 99% of Canadian oil exports get sent to the U.S.  Clearly, the current U.S. Federal reserve policy of Quantitative Guessing is very supportive of our long Loonie position.

It is estimated that energy contributes ~31% of Alberta's GDP and almost 5% of Canada's GDP overall, therefore the price of oil has a real impact on Canadian GDP.  As the price of oil increases, Canadian GDP will directly benefit.  Moreover, as Canadian production increases, energy’s contribution to Canada’s GDP will grow.  Currently, Canada represents ~6% of global oil production through ~13% of global reserves.  Over time, as we’ve seen throughout the last decade, Canada’s production share globally will begin to mirror its reserve share, which should create a major tailwind for Canadian GDP in the next decade.

Our Energy Team led by Lou Gagliardi recently released their top 10 list for energy investment ideas in 2011.  Not surprisingly, a number of these ideas were Alberta based energy companies.  So without further adieu, our top 3 Alberta ideas for 2011:

1. CANADIAN OIL SANDS TRUST (COS) – Mispriced conversion

The company is converting to a corporation from a trust at the end of December 2010. The stock recently took a hit on news that COS will cut its dividend payout ratio in half upon conversion to a corporation in order to maintain cash flow within capital spending. COS is 100% levered to oil sands production, as the largest partner (36.74% interest) in the Canadian Syncrude Joint Venture.

We view COS a company with upside earnings potential in 2011 -- potentially a 63% increase from 2010 to C$2.04/share at $85 oil, and net cash flow positive C$0.20/share after capital spending. At $89 per barrel oil, earnings could increase further to C$2.28/share, with net cash flow at C$0.45/share.  We view shares as oversold, as the market overreacted to the dividend reduction news, presenting a buying opportunity. COS is undervalued by roughly 30% according to our discounted cash flow models. The company's operating fundamentals remain strong, particularly with high oil price leverage.  The balance sheet has a moderate debt-to-capital ratio at ~23%, net of cash at ~21%.

2. NORTH AMERICAN ENERGY PARTNERS (NOA) – Predictable cash flow and dirt cheap

This Canadian oil sands resource "services" provider has been hit hard by the downturn in Oil Sands project expansion that began in 2009 and continued into 2010. NOA provides oil sands mining and site preparation, piling and pipeline installation services: as of the end of September, revenue from oil sands services generated 83% of net revenue, 84% of which is recurring revenue. Although its balance sheet remains under pressure at ~57% debt-to-capital and net of cash at ~50%, recent projected increases in capital spending by oil sands companies and the resumption of oil sands growth projects is good news for NOA, which will benefit from increased project spending.

Oil sands project growth will provide the catalyst to earnings growth into next year. For NOA's fiscal year ending March 2011, earnings are expected to decline 21% to C$0.61/share, but earnings for fiscal year 2012 (beginning in April 2011) should bounce back by ~120% to $1.36/share, driven by higher oil sands spending, which equates to just under 10x earnings. Net cash flow for both years should remain positive, with fiscal 2012 expected at $32 million or C$0.90/share.

3. MEG ENERGY (MEG) – Growth with a monster balance sheet

MEG Energy is a bitumen producer based in Calgary, Alberta with shares traded on the Toronto Stock Exchange. We expect MEG's 2011 earnings to benefit from a full year in operation, a 3% increase in oil sands production lower operating costs per barrel, and expanding margins. With its strong balance sheet, a strategic partner in China's CNOOC owning 15%, debt-to-capital at 21% and net of cash at negative ~13%, we believe MEG is being underpriced by the market by roughly 30%.

The company is sitting on roughly C$1.4 billion in cash -- more than enough to meet its expected net cash flow deficit after capital spending of roughly ~C$600 million for 2011. It is in the growth mode, ramping up production for its next phase of expansion at Christina Lake, with expected start-up in 2013. Based on $85 oil in 2011, MEG's 2011 earnings should top consensus, reaching ~C$0.92 per share, up more than 150% increase from 2010. Should crude oil average $89 in 2011, MEG's earnings could go about 16% higher to ~C$1.06.

You would be remiss not make your energy portfolio “Alberta Bound” in 2011.

Yours in risk management,

Daryl G. Jones

Managing Director

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