What are we looking for?
Value picks in the Canadian energy sector for potential takeovers.
The screen
With the recent announcement of the "megamerger" between Royal Dutch Shell and BG Group, investors may be on the lookout for more mergers or acquisitions on the horizon in Canada's oil patch. With U.S. Brent still sitting under $60 (U.S.) a barrel, the sector may be ripe for some additional consolidation.
This week, I took a look at stocks with low valuations in the energy sector. Specifically, I've ranked stocks based on the following factors:
- Enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA) – a valuation 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 to 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 may be viewed as attractive for potential takeovers.)
Only the energy sector was considered in this screen and stocks with market capitalization less than $400-million were excluded.
More about Morningstar
Morningstar 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.
What we found
I used CPMS to back-test this strategy from December, 2001, to March, 2015. During this process, 20 stocks were purchased and equally weighted. Stocks would be sold if they fell outside the top 50 per cent of the database. Over this period, the strategy produced an annualized return of 8.1 per cent while the S&P/TSX composite total return index returned 7.8 per cent. These long-term results aren't great, but it is worthwhile to note that the strategy picked up an 81.3-per-cent return in 2009 and 26.2-per-cent return in 2010 when oil prices came off their lows. The top 20 stocks that qualify under the strategy are listed here.
Investors are always advised to conduct independent research before purchasing the stocks listed.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.