**March 14th Issue of The JMRD Market Observer**

March 15, 2014

In This Week’s Market Observer…

 

  • Oil & Gas Services: An update on the Canadian Sector
  • Canadian Energy Services: Two Outta Three ‘Aint Bad; Q4 Beats, Dividend Increased, Guidance Maintained
  • Crescent Point Energy: Another Blowout Quarter; Moving Estimates Higher and Bumping Target to $51
  • NBF Markets Review – February 2014
  • Retirement Corner
  • Week at a Glance
  • Reads of the week
  • Economic Calendar
  • Earnings Reports

Oil & Gas Services: Pausing to Take Stock; We’re Still Quite Bullish on Services – Should We Be?

NBF analyst Greg Colman provides an update on the Oil & Gas Services sector, reasons to remain bullish and risks for the sector. Despite valuations that have rebounded from trough levels, Greg continues to have a favourable outlook for the sector. The outlook for the second-half of 2014 looks robust, driven by expectations for higher spending among the producers. Top picks include Canyon Services (held in the JMRD DIG Basket), Canelson Drilling, Essential Energy Services, Xtreme Drilling & Coil Services and Horizon North Logistics

  • Our opinion is clearly a bull stance … We cover 16 energy services companies and 14 are rated Outperform. Implied returns for our stocks average 23% with a range of 10% – 54%. We’re clearly positive on the space; but why are we bullish, where could this argument fall down and are the odds of a stumble increasing?
  • … with valuations moving higher as expectations get built in … Valuations have moved up on EV/EBITDA and p/NTBV. The TSX services sub-index is up another 10% in 2014, after 25% in 2013 (and up almost 50% from the summer 2012 lows). Looking at forward consensus EBITDA over the last six-to-nine months this performance has been largely (~90%) attributable to multiple expansion with minimal impact from forecasted EBITDA growth. But we note margin expectations are still below mid-cycle and it has been the highest growth businesses pushing multiples higher.
  • … but we believe continued upside is supported by leading indicators. Commodity prices are providing support and E&P cash flows are expected to rise. Further, the equity financing window has been opening for producers giving them even more access to cash – cash we believe should result in increased capital spending and demand for services. This trend is starting to materialize but we believe will play out in a bigger way during the second half of the year. Two pillars of demand continue to be critical: LNG pre-facility spending ramp (impossible now to listen to a conference call or read an MD&A from Canadian oilfield services without this three-letter word repeating ad nauseam) and continued growth in the oil sands.
  • Putting on our “bear” hat – where the bullish thesis falls down. Six potential developments could stall or derail the oilfield services rally: 1. Profit taking (services have had an exceptional run and as we hit spring breakup in March/April historically equities have lost steam), 2. More fully valued sector (investors may not bid multiples higher before realized earnings growth is more certain), 3. Spending doesn’t ramp (we have yet to see meaningful increase in capex) 4. LNG the gift/the curse (any negative newsflow or project announcements could stop momentum), 5. Unmeasured supply response (market saturated with supply before demand is able to provide torque for earnings growth), and 6. Negative commodity price developments.
  • So on balance … we’re still positive. Risks are out there, but overall we hold steadfast in our belief that services stocks move still higher in 2014. Our top picks in a universe of Outperforms fall into four baskets with various risk/return profiles: First the premium-multiple, production-focused companies with growth more independent from a ramping services environment: Secure Energy Services (SES-T, OP, $20.00). Second the names with highest torque to our “leading indicators” and a bullish uptrend in services supply-demand: preferred fracer Canyon (FRC-T, OP, $15.00) and preferred driller CanElson (CDI-T, OP, $8.50). Third, the deeper value picks that have not yet been the recipient of significant multiple expansion, our special-situation Xtreme Coil (XDC-T, OP, $6.00) and also on the coil side Essential Energy Services (ESN-T, OP, $3.50), boasting 20% debt-adjusted EBITDA/share growth in both 2014/5e. Finally, our choice for the best way to play WCSB infrastructure development, Horizon North Logistics (HNL-T, OP, $9.50).

Oil and Gas Services

Canadian Energy Services & Tech. – Two Outta Three ‘Aint Bad; Q4 Beats, Dividend Increased, Guidance Maintained

This week, Canadian Energy Services announced strong Q4 results and an 8% dividend increase, the 9th time the company has increased its dividend since the start of 2010. We recently bought CEU in the JMRD All-Cap Growth Basket at $25.93 owing to its strong growth profile and healthy industry dynamics. On Friday, the stock traded to a new all-time high, up 6% following its year-end results, last at $27.60. Canadian Energy Services is a provider of high-tech drilling fluids and specialty chemicals to oil and gas producers, which helps keep the drill hole clean and managing well pressures. Management and the board of directors are well alligned with shareholders as they continue to own a large-position of 11% of the company. CEU’s goal is to sell chemical and fluid solutions through the full oilfield life cycle. That means CEU is alongside the customer from the drill bit, to the completion of the well, to the fitting of the wellhead and pump jack and on to the pipeline and midstream market. The trends within the horizontal drilling industry are also good for CEU. Horizontal wells keep getting longer and the number of “fracs” per well are increasing. Longer wells and more “fracks” mean that more fluid is being used. The means more fluid is being sold by CEU. This is a business that should have the wind at its back for the foreseeable future.

HIGHLIGHTS

$36.7 mln EBITDA beats $33.2 mln street & $33.9 mln NBF

Both pricing & volume were ahead of NBF estimates, with the biggest derivation being CDN operating days 13% ahead of our forecast and suggesting market share of 35%, the highest in the company’s history and attributable to new customer wins as CEU continues to roll out new technology. Day rates, our proxy measure for overall revenue growth at both drilling and production services, were also modestly ahead of our forecasts, most notably in the United States (5% ahead) which is promising given the U.S. day rate also captures JACAM.

Dividend bumped again; now at $0.84/yr.

The monthly dividend was raised for the first time in 2014 (after two bumps in 2013), now at $0.07/sh starting in April from $0.065/sh. We calculate an ~73% payout on 2014e and 86% on 2015, which assumes an increase to $0.075/sh monthly or $0.90/sh annually (Exhibit 3).

Guidance reiterated; maintain our above consensus view

We anticipated a guidance bump which did not materialize (CEU maintaining guidance of $135 mln – $150 mln EBITDA vs. our unchanged expectation of $152 mln). With the benefit of hindsight, although we believe the environment is better than when guidance was stated in November, we suspect management may wait until after breakup to revisit.

Maintaining our Outperform and $30 price target.

Our DCF-based $30 target implies 12.1x 2015e EV/EBITDA, a premium to the 7.8x historic average, but in line with peer ECOLAB at 11.8x on current year. Outperform.

Canadian Energy Services & Tech

Crescent Point Energy Corp.: Another Blowout Quarter; Moving Estimates Higher and Bumping Target to $51

Crescent Point Energy (CPG) reported a strong quarter this week, beating on Cash Flow and production estimates, along with lower operating costs. The company continues to show the benefits of its waterflood project which is lowering decline rates. The company pays a 6.83% dividend yield and the stock was up 4% over the 2 days following Q4 results. CPG has been a long-time hold in the JMRD Diversified Income & Growth Basket. We recently trimmed our position to reduce the weight but continue to own CPG for growth and income.

Q4/13 Results & Year-End Reserves

HIGHLIGHTS

Higher Production and Lower Opex Drive Cash Flow Beat

CPG reported strong Q4 results well above expectations. Cash Flow of $1.35/share came in above our estimate of $1.29/share and 9% above consensus of $1.24/share with the beat largely due to stronger production growth and lower operating costs.

Operating costs declined 6% Q/Q largely driven by higher production volumes and less downtime as a result of improved field operations.

Q4 Production Hits Record and Exceeds 2014 Guidance

Q4 production increased 8% Q/Q to a record 127,641 boe/d which was well above our estimate of 122,929 boe/d and exceeded FY14 production guidance of 126,500 boe/d. This growth can be attributed to continued implementation of 25-stage cemented liner completions in the Viewfield Bakken and ongoing impact from waterflood, which combined have contributed to a lower corporate decline rate of sub-30% (vs 33% budget).

2P Reserves Increase 9% Y/Y to 664 mmboe

2P reserves increased 9% Y/Y to 664 mmboe (vs NBF 657 mmboe). CPG added 93.6 mmboe of 2P reserves mostly from improved recoveries and positive technical revisions, and replaced 213% of production at an all-in 2P F&D cost of $20.09/boe (incl FDC), driving an impressive recycle ratio of 2.6x.

Moving Estimates Higher and Increasing Target to $51

We continue to be impressed with the strong operational performance and organic growth being achieved by CPG and have increased our 2014 and 2015 production estimates higher as we fully expect CPG to exceed 2014 guidance. We reiterate our Outperform rating and are increasing our target price to $51 (from $50) which is based on a 1.1x multiple to our CNAV estimate and reflects a 2014 EV/DACF multiple of 9.6x.

NBF MARKETS REVIEW – FEBRUARY 2014

As the dust from last month’s dramatic sell-off in emerging markets begins to settle, investors continue to focus on the renewed vigour of the world’s advanced economies, which outclassed emerging markets by a sheer landslide since the beginning of the year.

Despite the geopolitical tensions that continue to beleaguer Ukraine, fears in emerging markets have subsided to some degree. As a result, emerging markets recovered their losses incurred in January. Though developed markets also recouped last month’s losses, they did so with a remarkable strut, with the MSCI World advancing by more than 4% in February.

Commodities for their part, rallied the most since July 2013. Gold continued to act as a safe haven throughout the month and led the charge in materials stocks and the S&P/TSX in February. After coming out of a difficult year in 2013, the yellow metal has surprised on the upside amid a backdrop of rising volatility and global uncertainty; realizing its second consecutive monthly gain.

Oil prices have also forged ahead, with long cold winters increasing consumption and depleting inventories in parts of North America. The U.S. was particularly victimized by this harsh weather, but impressive earnings results took precedence over less encouraging data, which are expected to bounce back to a certain degree once weather conditions improve. With softer economic data emerging at the end of the month, Janet Yellen stated before a senate committee that while the Federal Reserve will likely continue tapering its asset purchases going forward, a delay in its course may be in the cards in the event of a significant turnaround in the economy. This pledge for continued support sent stocks higher, with the S&P 500 moving into record territory during the month.

Overseas, the potential for increased monetary stimulus by the European Central Bank (ECB) bolstered demand for European bonds. Yields on Italian, Greek, Portuguese and German bonds dropped throughout the month. Fears over low inflation prompted many to think that the ECB could slash rates in order to offer more economic support. However, European officials announced on the last day of trading that inflation in the euro zone was higher-than-expected, which reduces the likelihood of a rate cut by the ECB.

Markets Review – February

Retirement Corner

“New Border Rules Spell trouble for Snowbirds” (Advisor.ca)

Week at a Glance

Week At A Glance

Reads of the week

“Bank of Canada Examines Loonie Fixings” (Bloomberg) The Bank of Canada said in an internal report that it’s examining the way its own reference rate for the Canadian dollar is set as pressure builds globally to prevent alleged manipulation of benchmark currency rates.

“Hootsuite Seen Leading Canada Technology IPO Rebound” (Bloomberg)

“Can Sobeys change leaders and conquer Western Canada at the same time?” (Canadian Business) Paul Sobey has finally retired, but not before taking one last gamble http://www.canadianbusiness.com/companies-and-industries/can-sobeys-change-leaders-and-conquer-western-canada-at-the-same-time/

“Teslas in California Help Bring Dirty Rain to China” (Bloomberg) As more environmentally conscious Americans do their bit to help clear the air by paying up for an eco-friendly Prius or a sporty Tesla, a damaging form of polluted rain is falling in China

“Traders Beat Market Indexes Borrowing Tools From Sports” (Bloomberg)

On UnionPay, China and smuggling money in Macau (Thomson Reuters)

Big batteries threaten big power stations and utilities’ profits (Economist)

“Kate Spade Faces Uphill Fight to Be Next Ralph Lauren” (Bloomberg)

Economic Calendar

Monday March 17th – Canadian Existing Home Sales, U.S. Empire Manufacturing, U.S. Industrial Production

Tuesday March 18th – Canadian Manufacturing Sales, U.S. CPI, U.S. Housing Starts, U.S. Building Permits

Wednesday March 19th – Canadian Wholesale Trade Sales, FOMC Rate Decision

Thursday March 20th – New Housing Price Index, U.S. Initial Jobless Claims, U.S. Existing Home Sales, U.S. Leading Index

Friday March 21st – Canadian Retail Sales, Canadian CPI

Earnings Reports

Monday March 17th – None

Tuesday March 18th – Alimentation Couche Tard, Oracle Corp

Wednesday March 19th – Power Corp of Canada, FedEx Corp

Thursday March 20th – Silver Wheaton, NIKE

Friday March 21st – None

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