It is somewhat understandable that high quality Canadian unconventional drillers are being shunned when investors have the option of jumping into Bitcoin, or the late stage NYSE stock rally. Clearly, these latter two investment vehicles have no risk and are a guarantee of high returns as witnessed by one of the longest winning streaks on record. The price rise of Bitcoin speaks for itself.
Taking my tongue out of my cheek, Iike many older folks who were around in 1987, 2000 and 2008/9, I am becoming increasingly nervous that stocks in the US could be approaching bubble territory and that a correction could be around the corner (or not).
In 2017, several Canadian companies have seen their shares prices drift substantially lower as this investment space has fallen out of favour. After reviewing the recent press releases outlining 2017 operational performance of two large Canadian unconventional drillers, I wondered how Canadian companies are valued against their US peers.
I looked at the Price/Earnings ratios of ten well known US independents operating in the Bakken, Eagleford and Permian. Five of these companies were operating at a loss as of Q-3 2017. Of the five profitable companies, three were trading at P/E’s greater than 100. The other two were trading at P/E’s of 40.05 and 26.82 as of January 11, 2018.
I looked at five Canadian unconventional drillers. Three are large independents with substantial natural gas liquids and condensate production and operate in the Montney, Duvernay, deep basin and the Permian. All three companies are very profitable with excellent return on capital deployed. Two of the companies traded at P/E’s of 17.60 on January 11, 2018 while the other traded at 17.00. The two other players are primarily natural gas producers and trade at multiples of 13.00 and 13.40. Using an eyeball approach, it looks on many days that the traders algo’s are dialed in over a small range between individual stocks.
Perhaps income tax rates explain the difference? The Alberta and federal tax rates total 27% (15% federal and 12% Alberta) versus 20% (as of January 1, 2018) in the US. In Texas there is a 2% severance tax plus sales and property taxes. In New Mexico there is a 6.6% state tax. Without doing an in-depth tax analysis comparing the various jurisdictions, a US tax advantage, does not explain the substantial valuation gap. We could also look at royalties, but I suspect the new 5% Alberta Crown royalty until payout compares very favorably with a freehold royalty rate of 15-17%.
I can’t explain why the Canadian companies trade at a substantial discount to their US peers other than the halo effect of the NYSE and Bitcoin and the fact that the market movers have discounted Canadian unconventional stocks for the time being. Given the strong market fundamentals and the financial strength of the Canadian companies, they are a yuuge bargain.