In April 2020, West Texas Intermediate (WTI) crude oil futures made history by trading in negative territory. At that point in time, it would have been hard to imagine that in less than 2 years that oil would…
be trading at multi-year highs.
Demand is already back to pre-pandemic levels, although there are some that believe a recession could lead to lower levels of demand over the next few quarters. However, this has already been priced into the sector, meaning there is upside if the economy can merely slow without contracting.
From the supply side, CAPEX remains low despite higher prices and has been low for the last few years. This means that oil is likely in the early stages of a multi year bull market. This week’s featured stock under $10 – TransGlobe Energy (TGA) – is well-positioned to benefit from these trends.
Company Background
TGA is an oil and gas explorer and producer that operates in Egypt and Canada. In its last quarter, the company produced about 15,000 barrels of oil per day, resulting in a positive cash flow of $24 million and net earnings of $14 million.
This is quite impressive given the company’s market cap is $248 million. Another aspect to like about TGA is that the bulk of its operations are in Egypt, where there are fewer environmental regulations. Over the last decade, the cost of producing oil in North America has significantly risen due to a tight labor market and increasing environmental regulations.
Oil’s Bull Market
The major catalyst for TGA is the bull market in oil. It’s remarkable that oil is now substantially higher than it was prior to the pandemic. And, there are some good reasons for it to keep going higher.
The main factor is companies have been focused on preserving cash given that oil has trended lower for the bulk of the past decade. This is a sharp contrast to the 2008 to 2011 period when CAPEX exploded as many believed that oil was going to permanently stay above $100. Ironically, most of these projects have failed to generate significant returns with a significant swathe of energy-issued credit going bust or downgraded.
Today is a much different environment. Despite the more than 100% rise in oil prices, CAPEX remains depressed. Additionally, many institutions are unwilling to invest in energy securities due to ESG guidelines.
On the demand side, the pandemic revealed that the world remains reliant on oil. And, demand will only increase as the travel volumes are once again picking up as coronavirus case counts decline.
Longer-term, demand will increase as an estimated 1 billion more people will enter the global middle class over the next decade. This will result in more cars on the road, refrigerators in the kitchen, and air-conditioners. This additional energy consumption will likely offset increases in energy efficiency.
Value
The upside case for TGA is quite obvious given the company’s impressive fundamentals and the fundamentals driving oil higher. However, the stock is even more attractive when considering its valuation.Currently, TGA has a P/E of 1.9. This is significantly cheaper than the S&P 500’s forward P/E of 15.
Another important valuation metric is free cash flow, especially for energy companies. Unlike earnings or revenue which can be gamed, free cash flow is a much more tangible figure. Here, TGA also shines with a P/FCF of 5.8. This means that at current oil prices, TGA is generating just under 20% of its market cap in cash.
POWR Ratings
Given this attractive picture, it’s not surprising that…
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