What are we looking for?
Undervalued oil and gas companies in Canada that have experienced more significant drops in net profit margins than their peers.
The screen
Last year will always be remembered as a tough one for the oil and gas sector as companies weathered a significantly lower commodity price environment.
Given all the sector's layoffs and production cuts, companies have thinned out their costs of revenue and labour to the point where these profit margins can be considered depressed. If energy prices bounce back in 2016, these margins should increase drastically due to the effect of increasing revenue. As profitability rebounds, so should the stock prices.
The screen begins by identifying undervalued oil and gas companies trading in Canada, with a market capitalization of more than $500-million, that have an enterprise-value-to-EBITDA ratio less than their industry median. (EBITDA represents earnings before interest, taxes, depreciation and amortization.) The EV/EBITDA ratio measures a company's true takeover value and can be compared with companies in the same industry to identify overvalued or undervalued situations.
Next, we added a filter to find companies with a lower net profit margin over the past 12 months compared with the industry median. The net profit margin will essentially determine what percentage of revenue will translate into profit. We're looking for companies in which margins have dropped more than the industry median to identify companies where cost reduction could potentially be bottoming out.
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What did we find?
The results identified seven companies that meet the criteria. AltaGas Ltd., a Canadian energy infrastructure company focusing on natural gas, power and regulated utilities, has the highest net profit margin at 2.4 per cent over the past 12 months. Although there has been a shift in management as David Cornhill has stepped down as CEO, the company is focused on retaining its current strategic direction and sees opportunity and growth geographically and by penetrating the California market through its acquisition of GWF Energy Holdings in September, 2015.
This commentary does not provide individualized advice or recommendations for any specific subscriber or portfolio. Investors should conduct further research before investing.
Patrick Gattuso works in the financial and risk unit of Thomson Reuters and specializes in asset management.