One of the biggest contributors to inflation raging around the world is the price of energy. Under-invested since 2014 due to a combination of cyclical oversupply and worry over the future of fossil fuels, oil and gas were already rising when Vladimir Putin invaded Ukraine. As a result of the invasion, countries in the democratic West, at least, are seeking new supplies.
“A couple of years ago the industry was left for dead. Oil was selling for US$20 or $30 a barrel,” says Russil Lea, portfolio manager in charge of Nicola Wealth’s Canadian equity funds. “Here we are just a few years later and everybody’s talking about $100 oil, $130 maybe.”
While the price spike and geopolitical concerns will likely hasten importing countries’ transition to renewable sources, the investment and infrastructure build will take years if not decades. In the meantime, people need heat for their homes and gas for their cars and Russia, until recently the world’s largest supplier, is fading from the picture.
That’s why Lea and his team have boosted the Nicola Canadian Equity Income Fund’s exposure to the energy sector to 20%, higher even than the S&P/TSX Composite. “We favour large-capitalization integrated producers and pipeline companies that meet our requirement for dividend growth potential,” says Lea. “Currently, generating free cash flow in the neighbourhood of 25% of revenues, these companies have a lot of capacity to buy back shares, increase dividends and possibly invest in decarbonization efforts that will position them well for maintaining sales even as the energy transition advances.”
Further, like many commodities, oil has seen spot prices well in excess of analysts’ consensus forecasts in recent months, which suggests that cash flow and earnings per share for the first half of the year may surprise on the upside.
Cyclical as it can be, energy is a tricky fit with a dividend growth mandate, Lea allows. But Canadian oil companies’ cash-flow situation gives them plenty of wiggle room should oil prices unexpectedly pull back.
“The stocks don’t need hundred-dollar oil to make the dividends work. They can make it work at $80, or $70, or $60. So, you have some downside protection,” he says. Plus, the Nicola Canadian Equity Income Fund plays in the large-cap space. When these stocks’ crude oil revenues go down, often their refining margins rise. Says Lea: “These companies should be in a good position to weather any storm.”
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