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By Ruth Saldanha | 02-07-2019

Top Canadian energy stock picks

Morningstar analyst Joe Gemino things Canadian oil supply could grow to 6.3 million barrels per day in the next decade; he likes Enbridge, Cenovus and Trans Canada

Ruth Saldanha : Canada's oil supply continues to surpass expectations and there is no shortage of growth opportunities for the sector. However, though the supply side is strong, pipelines are operating at maximum capacity, while much needed expansion projects continue to hit road bumps. Morningstar equity analyst Joe Gemino recently authored a report on Canadian pipelines and is with us here today to discuss his findings. Joe, thank you so much for being with us today.

Joe Gemino : Thank you for having me, Ruth.

Saldanha : What are the main findings of your report in terms of the outlook for Canada's pipeline bottlenecks?

Gemino : Well, right now, Ruth, what we are seeing is the pipelines are operating at full capacity. Canada's supply grew to a record 5.1 million barrels a day in 2018, but the country just doesn't have the takeaway capacity to support that level of supply and any further growth. Because of that we saw price differentials widen to some of the highest levels ever in 2018. To combat these higher differentials and lower price realizations we saw Alberta introduce mandatory production cuts and we saw producers turning crude by rail to move some of their supply out of the country. However, these actions are really just a bandage to a much larger wound that we see can only be healed through pipeline expansion projects.

Saldanha :: Do you see Alberta's production cuts as a one-time event?

Gemino : Well, right now, Ruth, we do see that as a one-time event. But if we do see any delays in any of these pipeline expansion projects and if we continue to see crude by rail not ramping up to the levels that the market was hoping that it would, I think we could then see Alberta think about future production cuts. But right now, we'd say, these would just last in 2019.

Saldanha : What is your overall supply outlook?

Gemino : Right. So, we see supply slowing in 2019 due to the production cuts. We see supply dropping modestly to 5 million barrels a day from the 5.1 million barrels a day. However, we see it climbing to 5.7 million barrels a day in 2023, and really, that's predicated on pipeline expansion. So, if some of these pipelines start to come into service, we will see producers be able to tap into their solvent-assisted technologies which we think will allow them to compete with other marginal global supply sources and we think even further supply can grow to 6.3 million barrels a day by the end of the next decade.

Saldanha : Finally, what are your top picks in Canadian energy and why?

Gemino : Right. So, our top pick in this sector is Enbridge Energy, the stock we see 30% upside, we see a 6.2% dividend yield. And right now, really, we see that the market is really underestimating the cash flows from the company. We think the market is a little concerned about potential underutilization from the Canadian mainline pipeline. But we think the market maybe mistaken just because any underutilization will only have a minor impact on the company and we think with Canada being able to ramp up their supply, we should see the mainline operating near 100% capacity within the next decade. And we also see the company in a strong position to be able to grow its dividend at another 10% again in 2020.

We also see Cenovus Energy as one of our top picks. It's one of our best ideas and it's a 4-Star rated stock here at Morningstar. We see vast upside in the stock. And really, what we see is, Cenovus is one of the leaders in solvent-assisted technologies. We think with the amount of reserves that they have in the ground that they will be able to bring on this low-cost production and we think they can lower the production to $45 a barrel WTI. However, with Cenovus we do need pipeline expansion to come out in order for them to tap into their growth.

We also see a lot of upside in 4-Star rated and narrow moat TransCanada. We see about 30% upside. The stock is yielding 5.6%. And it's a similar story to Enbridge. We think that the market is a little worried about some underutilization of the Keystone Pipeline System. But we think even if all the expansion projects are placed into service, in the next decade we'd see all the major pipelines operating near 100% capacity. And also, TransCanada offers even more attractive dividend growth. They plan to grow their dividend at 8% to 10% through 2021 which is something a target we think that they can hit. And if the Keystone XL is placed into service, we think they would be able to continue to grow the dividend somewhere near that level for a longer period of time.

And lastly, Ruth, we also see some upside in 4-Star rated names Canadian Natural, Imperial Oil and Inter Pipeline and we note that Inter Pipeline is yielding over 8% right now.

Saldanha : Joe, thank you so much for being with us here today.

Gemino : Thank you, Ruth. It was a pleasure being here.

Saldanha : For Morningstar, I'm Ruth Saldanha.