Sometimes, I like to play the contrarian. A friend once
told me nobody builds a statue to a crowd, and being a hero with
your investments sometimes requires zigging when everyone is
zagging. The energy sector has been lagging the S&P 500.
Its relative underperformance may present an opportunity for
outperformance if you think sector returns mean revert over time.
What is relative performance?
Relative performance measures the returns of a stock or sector
against another stock, sector, or market index. Relative
performance is usually measured either by comparing returns over
time or on a spread basis using a ratio of the assets being
compared. Institutional investors and hedge funds tend to
focus more closely on relative performance than retail
How much has the energy sector been lagging:
The ratio of the Select Sector SPDR Energy Fund (
) to the S&P 500 ETF (
) is trading near the lower end of its five year range.
The performance is even worse for the iShares Global Energy
). The ratio of the IXC to the SPY is trading at its lowest level
since 2007 due to the outperformance of U.S. stocks relative to
Between December 31 2012 and July 19 2013, SPY has posted a
return of 18.8%, while the XLE has recorded a return of
17.2%. The IXC is up only 6.8% and a clear laggard. Much of
the energy sector's poor relative performance came in 2011 and
2012. Investors have been more interested in financial and
retail shares this year. The SPDR Financial ETF (
) and SPDR Retail ETF (
) were up 27% and 29.6% respectively year to date through July
Global energy demand has been slow and refiners
Energy shares have been pressured by slower global growth,
especially the weaker tone of growth in the emerging world in
places like China, India, and Brazil. The International
Energy Agency,IEA, has global oil demand growing 1.1% this year to
90.8 mbd and 1.3% next year to 92.0 mbd. Political and social
unrest in Egypt and Syria has not been a clear benefit to energy
equities on a relative basis.
U.S. based refiners have been hurt by a narrowing of the
WTI/Brent oil spread (higher input costs relative to output
costs) and the increased cost of blending credits for
renewable fuels. These factors are out in the open. Valero (
) and Marathon Petroleum (
) recently lowered earnings guidance.
However, there are a few bright spots for the energy
All is not negative for the energy sector. Crude oil prices have
been rising in recent weeks and are generally improving the outlook
for company profits outside of the refining sector.
West Texas Intermediary has risen over $15/barrel since late
June, while Brent prices are up around $8/barrel. Although some of
the gain is being blamed on an unwinding of the Brent/WTI spread,
there are fundamental drivers at work.
First, China's apparent oil demand rose 4.8% m/m and 11.7% y/y
in June to 9.99 mbd. Chinese demand for oil may be
starting to improve.
Second, the glut of West Texas Intermediary crude oil in storage
seems to be loosening with the recent draw in
inventory. In recent weeks, WTI inventories have fallen
27.1 mln barrels from their high. A decline this time of the year
is normal, but the drop has been strong to the 5 year
average. Seasonally WTI inventories should be pressured into
the late summer or early fall.
Third, U.S. refinery run rates have been hot. Refinery
utilization was 92.8% at last measure and well above the 88.0%
recorded at the same time last year. Demand looks
Fourth, hot weather has helped to reduce natural gas inventories
which stood about 1% below the five year average in the week ending
Fifth, energy service providers are optimistic. It may be
fair to say that if the service providers are seeing healthy
growth, the energy industry is profitable. Energy
producers don't buy services unless they are intent on extracting
and drilling for product. Oil service names Halliburton (
) and Schlumberger (
) posted positive earnings surprises in Q2.
HAL made the following comment in its Q2 press release:
"We continue to be optimistic about Halliburton's performance
for the remainder of 2013, our ability to continue growing our
North America margins, and continued revenue and margin expansion
in our international business." HAL also has a $5 bln stock
repurchase plan in place.
In its Q2 report, SLB said "As a result, we continue to see
consistent growth as spending plans are confirmed by rig count
outlooks and customer activity. We remain confident in the industry
outlook, our strategic positioning in the markets in which we
operate the strength of our technology portfolio and in our ability
to further improve our overall performance."
What are some risks?
There is a lopsided large commodity fund long in WTI crude oil
futures. The latest data from the Commodity Futures Trading
Commission displayed large funds long 467,613 and short 88,248
futures and options contracts in the week ending July 16
. The net long expanded nearly 27,000 futures and options
contracts. Funds have been buying aggressively in recent
weeks. A decline in oil prices could dampen the outlook for
Investors may be using the Master Limited Partnership, MLP,
sector to exploit opportunities in the energy sector.
Investors may be seeking potential tax advantages and
attractive yields in form of returned capital, while believing that
MLP are more stable than straight equity. Many MLPs act as
toll ways charging a fee for the use of their pipelines and storage
facilities. As a result, they are less sensitive to energy
price swings than many other energy sector names.
Global growth is slow and crude oil prices have seen a sharp run
up in recent weeks.
Valuation looks cheapest internationally:
The table following displays the PE ratio based on forward 12
month earnings for the top five weights in the IXC. Notice
that U.S. firms display the richest values given that their forward
PE ratios are above the 10 year median value.
Furthermore, dividend yields on the non-U.S. based
companies are much higher than the dividend yields on the U.S.
companies Exxon Mobile (
) and Chevron (
How to seize the opportunity?
There are a few ways to try to exploit the energy sector's
underperformance. Here are some ideas:
First, one could buy the iShares Global Energy ETF (
) and buy the Proshares short S&P 500 ETF (
) at an equal dollar value weighting. At current prices, the
ratio is about 1.46 SH to 1.0 IXC. Essentially, this position
would leave an investor long energy names against the S&P
500. The position would make money if energy stocks
started to outperform the S&P 500. The opposite, of
course, is true. A continuation of the current trend would be a
money loser. You have to be a strong contrarian to play this
game. It is not for the faint of heart.
Second, the table indicated that international integrated oil
names offer attractive dividends and relatively low PE ratios to
their U.S. based counter parts. BP (
) or Royal Dutch Shell A Shares (
) may be worth a look. Both are Zacks Rank #3 (Hold).
) is a Zacks Rank #4 (Sell) and is less attractive based on the
Third, there are Zacks Rank #1 (Strong Buy) in the energy
sector. Gulfmark Offshore (
) is a Zacks Rank #1 in the energy service sector. The
ESP (Expected Surprise Predication) for GLF stands out with the
most accurate earnings per share estimates for 2013 and 2014 well
ahead of the Zacks Consensus Earnings Estimates. W&T
) is an independent oil and gas producer. It is a Zacks Rank #1 and
jumped from a Zacks Rank #3 a week ago. GLF and WTI provide a
way to invest in energy companies which are seeing upward earnings
estimate revisions, while trying to play for a stronger relative
performance in the overall energy sector.
CHEVRON CORP (CVX): Free Stock Analysis Report
GULFMARK OFFSHR (GLF): Free Stock Analysis
HALLIBURTON CO (HAL): Free Stock Analysis
ISHARS-GLB EGY (IXC): ETF Research Reports
MARATHON PETROL (MPC): Free Stock Analysis
ROYAL DTCH SH-A (RDS.A): Free Stock Analysis
SCHLUMBERGER LT (SLB): Free Stock Analysis
TOTAL FINA SA (TOT): Free Stock Analysis Report
VALERO ENERGY (VLO): Free Stock Analysis Report
W&T OFFSHORE (WTI): Free Stock Analysis
SPDR-EGY SELS (XLE): ETF Research Reports
SPDR-FINL SELS (XLF): ETF Research Reports
EXXON MOBIL CRP (XOM): Free Stock Analysis
SPDR-SP RET ETF (XRT): ETF Research Reports
To read this article on Zacks.com click here.