Portfolio manager explains how ‘golden era of free cash flow’ will drive new energy income strategy
For the better part of a decade, the Canadian oil industry was a challenging space to operate in, which also made it challenging to invest in. But after a confluence of secular, economic, and political tailwinds supercharged oil prices last year, the portfolio manager behind one of the last active energy funds standing says the outlook is brighter than it’s ever been.
“Last year, we were up 186%,” said Eric Nuttall, a Partner and Senior Portfolio Manager at Ninepoint Partners, who manages the Ninepoint Energy Fund. “And yet, when I look at energy stocks, they are cheaper today than they were a year and a bit ago, just because of the increase in the oil price and the impact that has on oil producers’ free cash flow.”
As a portfolio manager with a strong ability to marry macro and micro views, Nuttall says the Canadian oil market today is an inefficient, target-rich environment. As he identified opportunities for the fund – whose performance earned it a FundGrade A+ Award in 2021 – he also recognized that rising oil prices would set the stage for a strategy that would not only have a high conviction on the energy sector, but also take advantage of oil companies’ increased capability to pay dividends to their shareholders.
With that in mind, the company has launched the Ninepoint Energy Income Fund today. Nuttall’s second energy strategy, the new fund is now available in a mutual fund and an ETF version trading on the NEO Exchange under the ticker NRGI.
“We believe there’s a tremendous a lack of appreciation of just how much free cash energy companies are generating,” he says. “The environment that we're in now is the golden era of free cash flow, and there's a few components to that.”
According to Nuttall, the lean years following the 2014 collapse in commodity prices forced energy companies to slash costs drastically, and that cost discipline has been etched into the cost structures of today’s industry. Along with that, investors are demanding that rather than pursue aggressive growth, energy companies should allow capital to flow back to its shareholders in the form of dividends and buybacks.
“There is a recognition that the sins of the past – namely pursuing growth for growth's sake, which led to a depressed oil price and the incineration of nearly a trillion dollars in shareholder equity – must not be repeated,” Nuttall said.
According to Nuttall, Canadian oil and gas firms are moderating their growth plans and spending less on drilling operations than they did historically. With the windfall of excess cash they saw in 2021, firms strengthened their balance sheets by paying bondholders, which Nuttall says will continue in 2022. By next year, he predicts the Canadian oil and gas sector will be debt-free.
At the same time, he predicts the current trend of high commodity prices both in natural gas and oil will continue for the foreseeable future. With the average Canadian oil firm sitting on 15 years’ worth of inventory, he argues that the current outlook for shareholder returns in the form of dividends is very strong.
“For this new fund, we’ll also be writing calls on our underlying positions, which aren’t doing in our other pre-existing energy strategy,” Nuttall says. “Given how volatile the sector is, we expect to be able to take advantage of the embedded volatility premium and meaningfully increase our overall potential yield.”
In the current environment, he expects the fund will be able to purchase companies still trading at highly depressed prices, while maintaining the ability to pay dividends sustainably. In the spirit of under-promising and over-delivering, Ninepoint is looking to pay investors in the fund dividends at 5% initially.
“I always tell my management teams that we should set the bar of expectations low and beat it,” Nuttall said. “We think we're being very reasonable with that initial return, and we hope to do better in time.”