Market Outlook:
We believe we are in a cyclical bear market which is a function of rising rates and inflation, combined with lower profit expectations. Given the impacts that inflation and higher interest rates will have on demand, we expect a mild slowdown in economic activity this year. Much of this is already being priced into markets today, reflected in the S&P 500 forward earnings multiple declining from 21x to below 16x. As a result, we believe the downside in broad market indices should be limited from current levels and are seeing an increasingly attractive setup for equities later this year.
Russia’s unexpected invasion of Ukraine in late February 2022 further exacerbated inflationary forces. The attack spurred a swift response from the global community in the form of unprecedented economic sanctions in an effort to isolate Russia from the global economy. This effectively removed Russian supplies of a number of critical commodities from global markets, including oil, wheat, base metals and fertilizers. Soaring commodity prices have increased the risk of food shortages and a global energy crisis, particularly in Europe. Commodities have been caught up in broad market weakness due to recession fears. Despite the correction, most commodities are at prices well above average over the last 10 years.
Top Picks:
Arc Resources (ARX TSX):
Arc Resources is a premier Montney gas company that trades in line with peers and well below historic levels. It has a solid and growing 3.2 per cent dividend yield supported by a strong 18 per cent free cash flow yield. It has a combination of top-tier cost structure, large inventory, own infrastructure, strong balance sheet and execution track record. Shareholder capital returns target 50-80 per cent of free cash flow through base dividends and buybacks. It is expected to complete 10 per cent NCIB. It has a recent 15-year export deal tied to Japanese LNG pricing starting in 2027 (22 per cent of gas).
Whitecap Resources (WCP TSX):
It is a premier intermediate oil producer with an attractive 4.2 per cent dividend yield. It has a recent stock overhang from its $1.7 billion XTO acquisition of Montney and Duvernay assets. Insiders have been buying post-deal. The acquisition is highly accretive: 20 per cent to cash flow, production per share and free cash flow with 3-5 years growth for assets going from 32,000 barrels of oil equivalent per day (boepd) to 50,000-60,000 boepd. The market is likely concerned about leverage and implications for return of capital. The projected dividend is increasing by 65 per cent as debt levels come down over the next 12 months. There is an interesting ESG angle, given the carbon capture Weyburn unit (2MM tons) and 3-5MM tons in agreements for the Saskatchewan project.
CF Industries (CF NYSE):
The world’s largest nitrogen producer with operations primarily in North America. Nitrogen is one of the three key fertilizers including Potash and Phosphate. Nitrogen prices, like all commodities, are down from the peak (30 per cent) but triple the five-year average, so very strong. Two key drivers for nitrogen are gas prices and crop prices. Crop prices will remain strong especially given potentially weaker crops in U.S. and Europe. Secondly, structurally high gas prices in Europe will provide CF with a competitive advantage for margins and reduce supply from higher-cost regions.
| Disclosure | Personal | Family | Portfolio/Fund |
|---|---|---|---|
| ARX TSX | N | N | Y |
| WCP TSX | N | N | Y |
| CF TSX | N | N | Y |
Past Picks: July 6, 2021
Topaz Energy (TPZ TSX)
- Then: $17.22
- Now: $18.93
- Return: 16%
- Total Return: 16%
Troilus Gold (TLG TSX)
- Then: $0.95
- Now: $0.48
- Return: -49%
- Total Return: -49%
Osisko Development (ODV TSXV)
- Then: $6.75 (1-for-3 stock split May 4th)
- Now: $5.88
- Return: -71%
- Total Return: -71%
Total Return Average: -35%
| Disclosure | Personal | Family | Portfolio/Fund |
|---|---|---|---|
| TPZ TSX | N | N | Y |
| TLG TSX | N | N | Y |
| ODV TSX | N | N | Y |
Whether you have specific investment inquiries or general questions about Middlefield, our team would be glad to help.
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