I've found that one of the best ways to reduce my chance of making an investment mistake is to follow the lead of great investors with multi-decade track records of success.
Billionaire investor Wilbur Ross is one such investor that I follow. Ross' method of operation is to hunt for bargains in the most distressed areas of the stock market. And he seems to be pretty good at it. Ross has achieved an annual rate of return of 44% since 1997, according to an introduction given by investing legend Prem Watsa.
Ross recently revealed his interest in buying shares of beaten down Canadian energy producers. I closely follow these companies and I can tell you that current share prices are exceptional values.
Ross thinks now is a buying opportunity for Canadian producers, which have seen a severe decline in share prices, if you believe that the long-term outlook for oil is positive. Specifically, Ross is looking at small- and mid-cap companies because they have been hit the hardest.
The decline in oil prices has not hit Canadian producers nearly as hard as most investors think. A weakening Canadian dollar and shrinking price differential for heavy oil is offsetting the decline for these producers.
Oil is priced and paid for in U.S. dollars, but Canadian producers pay expenses in Canadian dollars (designated as CA$). That means when the Canadian dollar weakens and their expenses stay the same, then cash flows increase.
Let me crunch some numbers to show how this works.
At the start of 2013, the Canadian dollar was at par with its American counterpart. At that time, West Texas Intermediate, or WTI -- the benchmark for oil -- prices were around $90 per barrel. At par, Canadian producers received CA$90 per barrel.
Now fast forward to today. WTI oil prices hover around $80 per barrel, and one U.S. dollar is now worth $1.125 Canadian. That means Canadian producers are receiving CA$90 ($80 x $1.125) for each barrel produced.
I bet there aren't a lot of people who are aware that revenue being received by Canadian producers is exactly the same today as it was in early 2013.
For Canadian heavy oil producers, there is a second factor to consider: the price differential between West Texas Intermediate and Western Canadian Select.
Because Western Canadian Select is a heavier type of crude, it receives a lower price than WTI. For much of 2012 and 2013, that price differential became abnormally large because of pipeline restrictions.
Increased shipment of oil by railway removed the restrictions and the differential dropped to $15 from $30 a barrel at the start of 2013.
The combination of a weak Canadian dollar and a shrinking differential work together to offset the drop in oil prices.
The takeaway: Canadian producers are at worst earning the same money as in 2013 and at best are better off in this current climate.
In 2012, Western Canadian Select averaged $73.17 per barrel. In 2013, it averaged $72.77 per barrel. Today, it sits at $74.51 per barrel. When you factor in the Canadian dollar conversion rate, these companies are receiving better pricing today than they have over the prior two years.
Yet, like all Canadian energy producers their stock prices have been decimated of late.
Baytex Energy Corp. (NYSE: BTE) has heavy oil projects in the Peace River and Lloydminster areas on Canada -- two of the highest return oil developments in North America. Both offer payout of capital invested in less than a year, with Peace River doing so in an impressive six months. Those great economics give Baytex a huge advantage in all oil prices environments.
Baytex is also structured as a master limited partnership, requiring the firm to return a share of profits to shareholders. The firm has a 8.1% dividend yield, representing only a 35% payout of cash flow -- meaning that at current levels, its yield is sustainable.
Baytex operates with a solid balance sheet, with debt-to-funds-from-operations targeted to remain at a two-to-one ratio. That is much lower than what you would see for a typical U.S.-based MLP like Linn Energy, LLC (Nasdaq: LINE), which has a similar dividend but is leveraged at four-to-one.
Shares of Baytex have dropped to around $31 from $50 in just the last month, despite heavy oil's price holding up. At some point, the fear surrounding these companies is going to subside and the market will realize that fundamentals for heavy oil producers are actually quite attractive.
Risks To Consider: This can be a volatile sector and if oil keeps plummeting, then companies like Baytex are going to remain in the doghouse.
Action To Take --> Follow Wilbur Ross' lead and buy shares of Baytex Energy before the market realizes its true value.
If oil, natural resources or commodities are what interests you, look no further than StreetAuthority's Scarcity & Real Wealth. Our resident natural resources expert Dave Forest has more than a decade's experience as a trained geologist and analyst. His industry insight allows him to read the markets and provide the most timely, potentially lucrative advice for everything from oil and gold to molybdenum. To gain access to Dave's latest research, click here.