Sell in May? Nope, Buy in May and Stay, Stay, Stay

The sell off in energy stocks is opportunity, not catastrophe

Canadian energy stocks have fallen sharply from the hey-days of last fall. Natural gas prices have dropped from almost $10/mcf last year to ~$2/mcf today, and oil has fallen from a peak close to $120 a barrel to the ~$70 a barrel range. The Tweets on Twitter from energy investors are crying the blues. Pundits like Rod Nickel crowed that most Canadian E&P’s would be debt free by Q3 2023 able to “return more to shareholders” at the expense of lower capital budgets, with “buybacks” the preference of many. Not me.

In cyclical industries, money is made by buying whent commodity prices are low and stocks out of favor. Too many energy bulls have been caught out by their incessant bullish advocacy of “buybacks” gleefully thinking the companies of which they were owners should give their money to others to buy them out and reap the benefit of a higher share price based on fewer shares outstanding and the prospects of higher earnings and cash flows based on their hopes for a commodity “super cycle”. Most of them are taking a bath, but really would benefit from a cold shower.

ARC Resources (ARX.TO), Cenovus (CVE.TO) and Parex (PXT.TO) are three examples of companies who have outstanding assets and are wholly committed to buybacks. Together they have spent some * billion on share repurchases but the “reward” sought by the buyback crowd remains elusive if even present. A recession is looming and I suspect will see commodity prices fall further and energy stocks along with those prices. While the buyback crowd will sing the blues, those who bought dividend-friendly companies like Birchcliff (BIR.TO), Spartan Delta (SDE.TO) and Peyto (PEY.TO) have plenty of cash from the dividends they have received to buy into the recession induced collapse in stocks prices (if it happens) while those buying on margin to add to their favorite “buyback” king will watch from the sidelines.

COVID-19 provided a terrific buying opportunity for energy names and saw energy company boardrooms burn the midnight oil developing strategies to survive the collapse in energy prices and to benefit from the ensuing and quite dramatic recovery in those prices. The survivors were in two camps - those persuaded their stocks were “undervalued” and “buybacks” would serve investors will when debt was under control on the one hand and those who became persuaded that retirement of all debt and a dividend stream would provide the most benefit to shareholders. The pandemic is over, the surge in energy prices has abated, and it is time to review what worked well and what did not.

Here is a spreadsheet showing the value each company created since March 2020 including dividends and share price appreciation; the amount they made or lost on their hedge books; and, their average annual return from March 2020 through today (March 15, 2023).

Birchcliff produced an average annual return of 432%; Peyto 121%; and, Spartan Delta 209%. The companies preferred return money to ongoing shareholders through dividends to giving it to weak sisters who sold into buybacks, and except for Peyto (who lost a cumulative $368 million on its hedging activities) had profitable hedges. On average, these three (which comprise my largest holdings) returned an annual average return of 254%.

Cenovus spent $2.8 billion on buybacks; lost $2.6 million on its hedge book; and paid $1.2 billion in dividends and returned an average annual return to shareholders of 228%. Arc Resources spent $1.3 billion on buybacks; lost $2.2 billion on its hedge book; and, paid $521 million in dividends, returning an annual average return of 147%. Advantage Energy spent $288 million on buybacks; lost $85 million hedging; and, paid no dividends returning an average annual return of 142%. On average, these three (which I owned and traded out of in 2022 at a substantial profit) returned an annual average return of 172%.

There is no doubt that investors who had the courage to buy into energy names in March of 2020 have made out like bandits regardless of the strategy their company chose as between dividends and buybacks.

It is unfair to say the jury has rendered a verdict since the companies all have robust balance sheets, excellent asset bases; and, competent operating management and time will tell if the buyback strategy outpaces the dividend strategy over the long haul. But for the past three years, the dividend approach beat the buyback approach by a wide margin.

It may be of academic interest to see what the results had been if the companies in the buyback camp had eschewed hedging altogether and forgot about share repurchases in their entirety. It is fascinating (at least to me) how the companies that made the schizophrenic decision to both hedge (against lower commodity prices) and buyback shares (betting on higher commodity prices) would have fared had they done neither hedging nor buybacks, but suffice to say they would have produced stronger returns for their corporations and for the shareholders of those corporations.