The Suncor Refinery in Edmonton is seen on Tuesday, April 29, 2014. Suncor Energy Inc. has posted a nearly 70 per cent drop in net income during the second quarter as it took charges related to the cancellation of the Joslyn oil sands project and unrest in Libya.JASON FRANSON/The Canadian Press
Before Monday's apparent dead cat bounce, the price of West Texas Intermediate crude oil had been in free-fall in the wake of OPEC's decision to maintain a production target of 30 million barrels per day.
The S&P/TSX Capped Energy Index tanked along with crude, down 10 per cent from the conclusion of the cartel's meeting to Tuesday's close.
Though the drop-off in the loonie has somewhat blunted the impact of falling crude prices on domestic oil producers, the rate of return that can be generated by new projects has taken a considerable hit. As such, the outlook for capital spending and production increases has dimmed, and the Street has reacted accordingly by slashing its earnings estimates for the sector.
In a note to clients, David Rosenberg of Gluskin Sheff + Associates Inc. highlights the extent to which sentiment has shifted in a short period of time.
"The consensus view on TSX earnings for the energy space has been sliced to -2.7 per cent for 2015 from a +6.3 per cent forecast just a month ago," he said.
Mr. Rosenberg also suggests that these downward revisions may not have been sufficient. Despite the selloff in the sector, he notes, energy stocks are still being rewarded with a forward price-to-earnings ratio of 15.5 times. That exceeds the 14.7 times multiple for the S&P/TSX Composite as a whole.
An above-average forward price-to-earnings multiple is typically awarded to stocks or sectors that are expected to see more robust earnings growth relative to their peers or the overall index. If the forecasted decline in earnings comes to pass, the pain suffered by owners of energy companies could double should multiples contract along with the bottom line.
Along with cutting their earnings estimates, analysts are also raising questions about the sustainability of dividends in the energy space.
On Wednesday, Canaccord Genuity downgraded Talisman Energy Inc. and Baytex Energy Corp. A decrease in Talisman's payout is "very likely in order" according to analyst Phil Skolnick, who also thinks Baytex's dividend might be at risk as it has little room to cut capital spending.
Two sectors that Mr. Rosenberg finds more attractive than energy are health care and industrials. Both are expected to see earnings growth in excess of 20 per cent next year and trade at a similar forward multiple to energy stocks.
The sparsely populated health-care sector is dominated by Valeant Pharmaceuticals International Inc., which recently gave up its quest to acquire Allergan Inc. following a long, bitterly contested hostile takeover attempt. The company's third-quarter earnings showed organic growth that beat analysts' expectations, and its refusal to engage in a bidding war for the botox-maker gives the Canadian pharma giant the opportunity to pursue a major purchase in 2015.
Some industrial firms – namely, the airlines – stand to see their bottom lines benefit thanks to the decrease in oil prices. However, others in the sector, such as the railways and Finning International Inc., will be adversely affected if oil production growth slows.