CALGARY — Eight Canadian oil and gas companies are expected to storm into the all-important S&P/TSX Composite Index next month in a massive index change that analysts believe will spark a buying spree in energy stocks by index-focused funds.
Shares in Canadian oil and gas companies have outperformed the broader market this year thanks in large part to rising crude and natural gas commodity prices, declining leverage ratios and expanded pipeline capacity from Enbridge Inc.’s Line 3 replacement and TC Energy Corp.’s Nova gas pipeline system expansions.
The S&P/TSX Capped Energy Index has climbed 87 per cent year-to-date, outperforming the Canadian benchmark index’s 23 per cent jump.
Now, ATB Capital Markets expects eight Calgary oilpatch companies will be added to the key S&P/TSX Composite Index in the December rebalancing. The bank predicted in a Tuesday research note that index provider S&P Global Inc. will add Advantage Energy Ltd., Baytex Energy Corp., Freehold Royalties Ltd., Paramount Resources Ltd., Peyto Exploration and Development Corp., Secure Energy Services Inc., Tamarack Valley Energy Ltd. and Topaz Energy Corp. to the key index next month.
ATB expects five companies will likely be dropped from the composite index at the same time, including Sun Opta Inc., Martinrea International Inc., Organigram Holdings Inc., Real Matters Inc. and Westport Fuel Systems Inc.
Analysts and investors believe a handful of additional energy names, such as Nuvista Energy Ltd., are also poised to join the index in the early part of next year as the outlook for oil and gas commodity prices remains bullish.
For energy-focused investors, the potential of a massive reinclusion is a reversal of fortunes from just two years ago, when S&P Global kicked six Canadian energy companies off the index in one stroke. That trend began to reverse earlier this year, when Birchcliff Energy Ltd. rejoined the composite index , and now a larger group of its peers are set to follow suit.
“The industry is writing itself into the index,” said Rafi Tahmazian, partner and senior portfolio manager with Canoe Financial in Calgary, adding that inclusion on major indices has a “waterfall” effect, where an inclusion or exclusion from a key index leads to an outsized influx or exodus of investors in a given stock.
The industry is writing itself into the indexRafi Tahmazian, partner and senior portfolio manager, Canoe Financial
He said that more than half of the managed money in the market is passively managed in index-linked funds, so additions to the index often lead to dramatic moves in share prices.
“They have to chase what’s going into these indices,” Tahmazian said of passive fund managers, adding the same thing could happen in the first quarter of 2022 when more companies including Nuvista could make the cut to join the composite index.
Nuvista shares are up an astounding 671 per cent this year, rising $6.18 each to $7.10 per share on Wednesday. Despite that performance both Tahmazian and ATB think the company’s $1.6-billion market capitalization and trading volume may narrowly miss the December index rebalancing.
Tahmazian said he will continue buying energy stocks.
“Where, anywhere in the world, can you invest in something with 25 per cent free cash flow?” he said, describing the amount of money companies are generating in excess of their costs and dividend payments.
In addition to the S&P/TSX Composite Index, investors believe other indices have spurred buying in Canadian stocks.
New York-based index provider MSCI Inc. updated its MSCI Global Standard Index on Nov. 11 and added Calgary-based natural gas producer Tourmaline Oil Corp. to its benchmark list. Tourmaline shares are up 162 per cent, or $28.43 each, so far this year, reaching $45.94 per share Wednesday.
Tourmaline’s sister company, Topaz Energy, is poised to join the main Canadian index in December and could benefit from also joining the S&P/TSX Composite ESG Index, Jantzi Social Index and S&P/TSX Composite Carbon Price Index, according to a Raymond James research report.
“As Topaz continues to improve trading liquidity and the investment community updates Topaz’s ESG score with the release of its inaugural ESG sustainability report… we could see more index buying very soon,” Raymond James analyst Jeremy McCrea and George Huang wrote in the report.
When a company is added to an index, it directly increases the demand for the stock among passive fund managers, ATB Capital noted.
“Index inclusions and removals remain an important attribution factor for share price returns both for direct index-linked reasons like ETFs, mutual funds and derivatives, and index changes impact many institutional investors’ addressable universes and benchmarks,” ATB analysts wrote in a Tuesday note.
The bank believes the addition to the S&P/TSX Composite Index will boost demand for a company’s stock by 5.5 per cent of its total float, while addition to the MSCI Global Standard Index will boost demand by 3 per cent.
Between rebalancing by TSX and MSCI and share buybacks by energy companies, NinePoint Partners senior portfolio manager Eric Nuttall said he believes passive buyers will spend more than $3 billion on Canadian oil and gas stocks before the end of the calendar year.
“The market cap of the TSX Energy Index is about $220 billion, so about 2.5 per cent of the entire float in the next month,” Nuttall said, adding that he thinks the passive buying will encourage “FOMO on the part of the underweight fund managers.”
“There is some pre-positioning,” Nuttall said, noting that volume trading has increased in the companies most likely to be included in the December rebalancing. He considers Tamarack Valley and Nuvista’s inclusion in the main index “too close to call.”
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