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Oil & Gas and Gold Mining Stocks Among the Most Undervalued with Strong Fundamentals in Jan 2023

Equity screens are typically an easy way of finding a mismatch between the valuation metrics and the underlying fundamental drivers of cashflows, growth and risk of equities. In the following analysis, North American public equities and their corresponding sectors which are trading at low valuation multiples with strong fundamentals, low risk, high growth rates and high quality of growth, relative to the North American public equities, are further studied and presented.


The population in this study included all companies that are trading on the North American stock exchanges. Valuation multiples used for pricing screens include price to book (P/B), 2023 forward price to earnings (FY1 P/E) and enterprise value to last twelve months earnings before interest, tax, depreciation and amortization (EV/LTM EBITDA) multiples. As many micro and small cap companies are missing the FY1 EBITDA forecasts, the LTM EBITDA numbers were used for the purposes of this calculation. Given the macroeconomic environment in 2022-24 and the rising rate environment, we focused on leverage ratios such as debt to equity and net debt to net cap ratios to screen for risk. Growth screens were determined by operating income and net income forward growth rate estimates. Finally, the quality of growth is assessed based on return on capital and return on equity measures.[1]


The following tables display the 10 deciles of screening criteria across the data set for companies listed on North American exchanges, companies incorporated in the US, and companies incorporated in Canada.

Ten Deciles of Screening Criteria Across the Data Set for Companies Listed on North American Exchanges
Ten Deciles of Screening Criteria Across the Data Set for Companies Listed on North American Exchanges
Ten Deciles of Screening Criteria Across the Data Set for Companies Incorporated in the US
Ten Deciles of Screening Criteria Across the Data Set for Companies Incorporated in the US
Ten Deciles of Screening Criteria Across the Data Set for Companies Incorporated in CA
Ten Deciles of Screening Criteria Across the Data Set for Companies Incorporated in CA

We then plotted the difference between US and CA deciles of the data across price, risk and growth.


As displayed in the graphs, Canadian companies have performed better relative to the US counterparts as of the date of this analysis given lower valuation metrics, lower leverage, higher growth and higher quality of growth across almost all deciles of the data. US companies have performed better only from an ROE perspective across all deciles of the data. This observation is in line with the expectation that small cap, value stocks are expected to perform better during periods of high unexpected inflation and during a rate rising cycle. Moreover, Canadian companies have a much smaller market cap relative to their US counterparts.

Difference Between US and CA Deciles of the Data Across Price, Risk and Growth
Difference Between US and CA Deciles of the Data Across Price, Risk and Growth

The negative difference between CA and US valuation multiples represents the fact that Canadian companies are trading at lower valuation while a positive difference between CA and US revenue growth, operating income growth, net income growth, ROC as well as negative difference with respect to leverage ratios represent their stronger relative fundamental performance.


In order to screen for undervalued companies with strong fundamentals, we ran two sets of screens across the entire North American market and across companies incorporated in the US and CA regions.


Looking for mismatches among pricing and fundamental drivers of cashflows, growth and risks:


1) under the equity screen approach, a low PE ratio represented by the bottom 30th decile of the data, accompanied by above median (50th percentile) net income growth, low leverage (bottom 30th decile) and high ROE (top 40th decile) screens for companies that are undervalued relative to the entire market and have strong fundamental drivers.


2) under the enterprise value screen approach, low EV/EBITDA (bottom 30th decile), above average operating income growth (50th decile), low leverage (bottom 30th decile) and high ROC (top 40th decile) resulting in undervalued companies relative to the entire market with low risk, high growth and high quality of growth.

Equity and Enterprise Value Cashflow, Growth and Risk Screen Bounds as of Jan 9, 2023
Equity and Enterprise Value Cashflow, Growth and Risk Screen Bounds as of Jan 9, 2023

As noticed above, Canadian companies have displayed lower valuation multiples, higher growth, lower leverage and higher quality of growth from an enterprise wide perspective relative to the entire North American market as well as US incorporated companies.


We applied the ‘ALL’ criteria bounds to the Equity and Enterprise Value screen of All North American data. This led to the list of companies that are undervalued relative to the entire North American markets but have strong fundamental drivers. The red text are the companies that have displayed positive return for the Jan 3rd, 2022 to Jan 9th 2023 time period (an approximately 1 year time span).

Equity Screen Results of All North American Exchange Companies
Equity Screen Results of All North American Exchange Companies
Enterprise Value Screen Results of All North American Exchange Companies
Enterprise Value Screen Results of All North American Exchange Companies

Among US companies, VAALCO Energy Inc (Oil & Gas Exploration & Production), Bank7 Corp (Regional Banks), Harte Hanks Inc (Advertising), Sensus Healthcare Inc (Health Care Equipment), TimkenSteel Corp (Steel) and SIGA Technologies Inc (Pharmaceuticals) were among the undervalued companies with stronger fundamentals that displayed positive 1 year return as of the date of the analysis.


Applying the ‘CA’ criteria bounds to the Equity and Enterprise Value screens of Canadian companies, led to the list of Canadian companies that are undervalued relative to the entire Canadian market but have strong fundamentals. The red text are the companies that have displayed positive return for Jan 3rd, 2022 to Jan 9th 2023 time period.

Equity & Enterprise Value Screen Results of All Canadian Incorporated Companies on North American Exchanges
Equity & Enterprise Value Screen Results of All Canadian Incorporated Companies on North American Exchanges

Among CA companies, CES Energy Solutions Corp (Oil & Gas Equipment & Services), Vermilion Energy Inc (Oil & Gas Exploration & Production) and Amerigo Resources Ltd (Diversified Metals & Mining) were among the undervalued companies with stronger fundamentals that displayed positive 1 year return as of the date of the analysis.


Small/micro/nano cap value stocks have performed much better relative to large cap stocks, and this is in line with the size factor ouperformance as historically small caps have performed better when inflation is higher than expected which represents the return of the small cap premium during periods of higher unexpected inflation.

Value stocks and low P/B stocks perform better when inflation is higher than expected as well.


Given the strength of commodity markets, Oil and Gas exploration and development, refining and marketing and equipment and services were among the top performing sectors. Gold mining companies were among the Canadian undervalued equities with gold being the best hedge against high unexpected inflation. With the strong outlook for commodity markets, it is important to separate the view of the commodity market from the fundamental performance of the company to be able to choose public equities that can perform best due to their strong fundamental drivers and not do to sector outperformance.


[1] Forward estimates are sourced from Refinitiv. The estimates are either the mean of analyst estimates or the Smart Estimate, a weighted mean of analyst forecasts.


Source:

Data in this Blog is sourced from Refinitiv as of Jan 09, 2023, market close and includes equities listed on North American exchanges.

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