The most tempting values among oil patch stocks

Investment banking action is heating up in the oil patch after a prolonged period of investor apathy. Professional money managers consider this an extremely encouraging sign for investors in the sector.

The previous slowdown in new share and debt issues signalled that most investors thought the industry overvalued relative to the profit outlook. The lack of interest forced companies to put planned new issues on hold.

When activity picks up, it suggests that prices have fallen sufficiently to tempt investors back into the sector with the promise of potential bargains.

With that in mind, let's sift the oil patch for opportunities.

The accompanying table (below) shows the results of a valuation screen of all 61 companies in the S&P/TSX Energy Index. We used trailing 12-month price-to-cash-flow ratios to uncover fundamental value because cash flow is much harder to manipulate than earnings. The table shows the 15 most attractively valued stocks ranked by their price to cash flow over the trailing 12 months.

We then used forward price-to-cash-flow multiples (the stock prices divided by the average analyst estimate for cash flow for the next 12 months) to incorporate the outlook for each stock. In search of companies with positive earnings momentum, we also looked for stocks where analysts had raised their profit estimates by large amounts during the past three months.

Ideally, the screen would have uncovered a large, well-known Canadian energy company trading at a deep discount to historical valuation levels while its outlook was improving. Unfortunately for risk-averse investors, the value appears to be confined to smaller cap issues where operational risks and stock price volatility will likely be higher.

Lightstream Resources Ltd. and Gran Tierra Energy Inc. look to be the best candidates for further research. Their earnings estimates have climbed over the past three months and they look attractive on other metrics as well.

(Two other companies on our list also enjoyed rising earnings estimates, but both have other issues: Advantage Oil and Gas Ltd. trades at a prohibitively high trailing price-earnings level above 50, while Ensign Energy Services Inc., looks reasonably valued, but has had only a small bump to earnings-per-share estimates.)

Lightstream scores well on all measures except trailing price-to-earnings, which might not be a big deal for a fast-growing company. It is the cheapest in terms of forward cash flow estimates, and analysts have raised profit expectations by almost 40 per cent in the past three months.

Gran Tierra looks attractively valued across the board, although not quite as compelling as Petrominerales Ltd. and Lightstream on cash flow. (Petrominerales is the cheapest stock based on trailing cash flow, but unfortunately for investors, that ship has sailed. The company recently agreed to be acquired by Brazil-based Pacific Rubiales Energy, sending the stock sharply higher since the deal was announced in September.)

To be sure, these are smaller companies and you should expect their share prices to be volatile. Do your own research before buying, but the data imply these two oil-patch stocks could be ready to outperform

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The energy sector's best bargains

Scott Barlow writes for Inside the Market (tgam.ca/inside-the-market), which offers up-to-the-minute analysis of stock trends and market-moving news throughout the trading day. Subscribe to Globe Unlimited at globeandmail.com/globeunlimited.