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Market Watch Weekly - April 25, 2014

Erik Dekker - Apr 25, 2014
We end this week on a softer tone in the markets after what, for us, was quite a positive week in the capital markets.

We end this week on a softer tone in the markets after what, for us, was quite a positive week in the capital markets. Recently, one of the stronger performing economic sectors within the market has been the energy sector and as many of our readers know, we continue to own energy to varying degrees for our clients.

This week we will talk about how the value of the Canadian Dollar impacts the energy sector, as many people do not realize the significant impact that our currency can have. Last week, Canaccord Genuity’s energy research team, headed by Phil Skolnick, published their global energy themes for the second quarter which illustrated the impact of a lower Canadian Dollar.

Canadian energy producers not only see the value of their companies tied to the associated commodity price - which is not actually the WTI (West Texas Intermediate) price we all see on the news every night but rather the WCS (Western Canadian Sedimentary Basin) price - but also the relative value of our ‘loonie’ versus the US Dollar. Currently our energy research team feels that the markets have not rewarded Canadian producers for the tailwinds within our currency. International investors in particular have become comfortable enough not to worry about an appreciating Canadian currency eating into their profits as they repatriate those investments into their home currency. This is a key point within the currency tailwinds argument for owning the Canadian Energy Producers.

The Canadian Dollar has been somewhat range-bound recently at the low 90 cent level.  Martin Roberge, our analyst who made an early call on our Dollar falling to this level last year, is currently forecasting the Canadian Dollar to continue at the 90 cent level for the remainder of 2014 and possibly move towards the 85 cent mark during 2015. So, how will Canadian energy producers be affected if we have a currency that remains at its current levels or weakens further?

Every $0.10 decline in our currency roughly equates to an average increase in cash flows for those producers of approximately 13%. This comes about as companies sell their production in US Dollars, but incur the cost and expense of achieving that production in Canadian Dollars. Therefore as our expectation is for the Canadian Dollar to remain at or near the 90 cent level with a possible decline, we expect to see the Canadian energy producers such as Suncor and Crescent Point Energy realize growing cash flows. It is these growing cash flows that we would then expect to translate into higher capital market valuations.

So while we might not like a decline in the loonie when it comes to paying higher prices at the pumps and travelling to the States, we certainly like it when it comes to owning the Canadian energy producing companies.

A couple weeks back we wrote that if you expect to outperform the crowd, you have to do things differently, in essence avoid the “herd mentality” of doing what everyone else is doing. The question then becomes, if international investors are moving into owning Canada’s energy sector companies currently, how do we add value without chasing risk?

Sometimes the easiest thing to do when investing in the capital markets is to follow the herd, which in this illustrated case would be to simply own the energy sector ETF (exchange traded fund). While that is certainly not a bad option, it is one that we feel does not add significant long term value for clients.  While you would own companies like Suncor and Crescent Point Energy within the energy sector landscape, you would also own the Canadian energy companies that are not growing production or their cash flow.

It is our belief that if you simply look to own every energy company in Canada, you are unknowingly adding risk to your portfolio by also owning companies that are not growing. We firmly believe that investors will receive greater potential long term value with possible lower risk to their invested capital by taking a more concentrated approach.

This is not to say “don’t own an index ETF”, as they do serve as very good vehicles for investors with less funds to invest, where individual asset management within a portfolio context is not practical. What we are saying is that within a larger context of portfolio management, at the present time taking a more concentrated investment approach within Canada’s energy sector is where we see tremendous value.

As parents we often like to boast or brag a bit when a child accomplishes a goal that a considerable amount of effort was put into achieving. I am no different in that, so this week I want to end with a congratulations to my daughter Tessa who was accepted into the Architectural Sciences Program at BCIT.

Have a great weekend.

Thank you for your trust.

As always, we welcome any feedback.

The Dekker Hewett Group