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A vote against the Alberta oil sands — for now

As the environment becomes a hot-button issue, this U.S. advisory sees the Alberta oil sands as a short-term casualty.

Since we have always found it worthwhile to write about the good things that U.S. advisories have to say about Canadian stocks, we think it only right to report the news when a Canadian stock is getting downgraded.

In this case, it’s two stocks. Two big ones — Petro-Canada and Suncor. It’s all about the oil sands and the march of environmental consciousness.

Writing in The Complete Investor, Mr. Stephen Leeb tells a cautionary tale of the Oscar-winning environmentalism of Al Gore and of a U.S. firm compelled to scrap its plans for eight new coal plants before being bought out.

“These are just two out of many recent signs that the environment has become hot — not just literally, as in global warming, but as a public hot-button concern.”

Dirty energy and the need for water

And that has caused Mr. Leeb to rethink this advisory’s endorsement of Alberta’s oil sands as a hotbed of investment wealth. (By the way, Mr. Leeb refers to these deposits under their old name of “tar sands” which may sound to some like a site to dig for dinosaur fossils, but .... what’s in a name?)

The wave of environmental-friendly sentiment has caused The Complete Investor to sell both Suncor (TSX/NYSE-SU) and Petro-Canada (TSX-PCA; NYSE-PCZ). “Both are great companies and are among the very few producers of fossil fuels with the potential to increase energy production at a rapid clip for the indefinite future. But that potential comes from their stake in Canada’s tar sands, one of the dirtiest energy sources around.”

He is not entirely discouraged. “We still have no doubt that the sands will be developed, but we’ve grown increasingly concerned about the companies’ exposure to the potentially huge and unknowable costs of environmental cleanup. In addition, developing the tar sands requires large inputs of energy as well as another scarce resource, water; the water problem could dramatically slow down the pace of development.”

The result of these uncertainties seems fairly certain to Mr. Leeb. “These will likely translate into ever lower P/Es as well as an earnings trajectory lower than we had anticipated, and we no longer think the risks are worth taking.”

Not oil but natural gas

To replace the banished stocks, The Complete Investor turns to two rather interesting alternatives. One is PetroChina (NYSE-PTR.N), but not for oil. With a company this big, says Mr. Leeb, “growth is hard to come by, and indeed, as far as oil goes, PetroChina will be lucky to maintain current production levels over the next three to five years.”

Natural gas, he says, is another story. “We think production will grow by 15 per cent or better for at least the next three years, leading to overall production growth of around 5 per cent a year. This beats any super-sized oil company in the world.”

The company is also primed for acquisitions as the yuan gains ground against the dollar. “PetroChina’s excellent balance sheet and nearly 5 per cent yield are additional positives. Even if energy prices remain relatively flat, earnings growth could approach 10 per cent a year over the next few years. Our first goal is the recent highs in the 140-145 areas, with much higher prices thereafter.”

More natural gas

The second substitute stock is a drilling company, Nabors Industries (NYSE-NBR) which “offers a combination of compelling valuations and a dominant market position that is simply too good to pass up.”

The largest land driller in the world, Nabors generates well over 50 per cent of its business from natural gas drilling in the United States. In 2006, its earnings jumped by 80 per cent despite the drop in gas prices.

The company has grown internationally, and should maintain its growth rate of better than 25 per cent a year, barring a worldwide recession. “Over the past several years,” says Mr. Leeb, “despite a frantic increase in drilling, natural gas production in the U.S. has declined.” So if Nabors’ business falls off it will be good for Nabors’ business, so to speak. A fall-off would accelerate “the drop in gas production, which in turn will be a catalyst for a sharp rebound in drilling.”

Nabors’ earnings are likely to rise between 10 an 20 per cent in 2007 and grow at a 15 to 20 per cent pace in the future. There’s another factor in the future. “There are solid reasons why Nabors is rumored to be a takeover candidate. But with or without a takeover, the stock is a buy, with a target of 50 in the next 18 months.”

A Canadian buy

We would be sorry to leave you without a good word for Canadian stocks. Fortunately, this issue of The Complete Investor has just such a bon mot in a separate article on agriculture by Mr. Ari Jahja.

The advisory is bullish on agriculture, largely due to the demand for ethanol (which Mr. Jahja doesn’t see as a long-term energy solution, although he thinks it will continue to be produced in large quantities). And one winner in the worldwide agricultural boom is Potash Corp. of Saskatchewan (TSX/NYSE-POT).

It is, Mr. Jahja explains to his readers, “the world’s largest fertilizer company by capacity.” He adds that the company controls more than 75 per cent of the world’s excess potash production capacity, allowing it to keep pace as demand grows. “We rate Potash a buy, with a 12-month target of 165.”

In the meantime, many investors will be hoping that this advisory’s take on the oil sands is more a false alarm than an inconvenient truth.