In this series, I (Jin Choi) talk about my journey of investing in my TFSA account. If you want to know what a TFSA is, I recommend you read my free book. In this update, I’ll give my thoughts on the current state of the Canadian oil and gas industry.
April Results: Up 12.3%
At the end of April, I had $46,898 in my TFSA account, which is up by 12.3% since the end of last month. By comparison, the Canadian stock market went up by 3.0% while the U.S. stock market went up by 4.4% in Canadian dollar terms. Therefore, my portfolio outperformed.
The majority of my portfolio consists of Canadian oil and gas stocks. Oil prices rose again in April, going from $60.19/bbl to $63.83/bbl (in US dollars). One reason Canadian oil prices have stayed strong is because of Alberta’s decision to curtail production. My oil and gas stocks did well as a result.
Despite the recent rise in oil and gas stock prices, I still view these stocks as being criminally undervalued. The latest round of earnings reports bear this out, as many companies reported healthy free cash flows.
“Free cash flows” are akin to “earnings” in the sense that they measure how much richer a company has become after a period of time. But unlike earnings, free cash flow only measures how much cash the company accumulated during the period in question, which makes the measurement less susceptible to accounting distortions. Financial analysts therefore often give more weight to free cash flows over earnings.
The largest position in my TFSA is Baytex Energy (Ticker: BTE). During the first 3 months of this year, BTE reported free cash flows of around $70 million. Also, according to their latest presentation, management projected that they’ll achieve roughly $300 million in free cash flows at current oil prices. To put this in perspective, BTE is currently valued at $1.5 billion, which means that the company is trading at just 5 times the projected free cash flow, which any financial analyst will tell you is very cheap.
Now, some might say, “So what? We’ve seen this movie before.” As soon as oil companies get some cash, they seem eager to spend it all on drilling new wells, which in turn leads to an industry-wide production increase and a subsequent crash. But this time, there are signs that oil companies are following a more sensible route.
Take Crescent Point, for example, which is another stock I own. A few months ago, the company announced that it would use some of its free cash flow to buy back stock instead of putting that money towards more drilling. As I’ve explained before, buying back shares when the company is cheap is generally very beneficial for its shareholders. Crescent Point is not the only one buying back shares, though I wouldn’t say the practice is widespread as of yet.
But even with companies’ willingness to follow more shareholder friendly policies, I understand why some investors feel nervous about investing in oil stocks today. The last oil price crash occurred just this past fall as oil went from $76/bbl to $44/bbl, so it’s still very fresh on investors’ minds. However, I believe that such sentiment is just a manifestation of recency bias.
Recency bias is a psychological phenomenon that states that people tend to remember and emphasize recent events more than events in the more distant past. Rationally speaking, there are just as many reasons for oil prices to spike as there are for it to crash.
In fact, we may be starting to witness one such path to an oil price spike. In the past few days, Saudi Arabia saw its oil tankers and pipelines come under attack from forces sympathetic to Iran. The White House is also said to have reviewed plans to attack Iran, should it show signs of trying to develop nuclear weapons. If a war does erupt in that region, it’s possible that many millions of barrels a day worth of production will come off line, almost certainly sending oil prices north of $100/bbl.
Now, I’m not saying that such a scenario is likely. I don’t think Iran will provoke the US enough to cause a war, since they must understand that they’ll lose. But geopolitics is extremely hard to predict, and a war remains within the realm of possibility.
Instead, all I will say is that at present, oil prices could just as likely spike as crash, so I believe it’s reasonable to analyze oil and gas stocks using current oil prices. Since my oil and gas stocks look very undervalued at current oil prices, I still feel comfortable hanging on to them, for now.