Markets

Why Money Managers Say Energy Stocks Have Not Run Out Of Gas

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Are energy stocks and mutual funds about to run out of gas? Or have they still got fuel in their tanks? Energy-focused stock mutual funds have been turbocharged during the past year. They've gained roughly twice as much on average as the broad market in the form of the S&P 500, in the 12 months ended Jan 18. Their average 12-month trailing yield is more than double the S&P 500's.

In addition, they've outperformed and provided higher yield than income-oriented stock mutual funds overall as well.

Many companies involved with energy production have highly appreciated share prices. The question going forward is, can they keep it up?

Their kissing cousins, power utilities, have the opposite problem. Many have sold off, giving a big boost to their dividend yields. Seen by many investors as proxies for bonds, many utilities sold off in the run-up to the Federal Reserve's December interest rate hike and the prospect of future hikes. So, can these rally?

Robin Wehbe, a manager of $313.7 million Dreyfus Natural Resources ( DLDRX ), says energy stocks still have room to run in part because the oil downturn forced many to begin cutting costs. Ongoing cost-cutting combined with stable oil prices around $50 a barrel or higher assures many oil services firms of a path to profitability, he says.

Skip Aylesworth, co-manager of $1.4 billion Hennessy Gas Utility ( GASFX ), says many natural gas distribution companies are now geared to be profitable with the price of gas above $3 per million metric British thermal units (mmBTU), and the fuel is above that threshold.

In addition, many state regulators have begun to offer local and regional utilities rate formulas that are more profitable if the utilities replace aging underground pipes. Pipe replacement is often a 10- to 20-year process, Aylesworth says. So incentives can give utilities a way to transform 2% to 3% annual earnings into 9% to 11% for decades, he adds.

Jay Hatfield, manager of InfraCap MLP ETF ( AMZA ), expects oil to break out of its $50 to $55 range and trade as high as $70 as the summer driving season approaches. Energy infrastructure MLPs should benefit, he says, as many are still trading at what he sees as oversold prices.

IBD's TAKE:This IBD report looks at strategies for deriving income from dividend stocks at a time when rising interest rates are clobbering bonds and bond proxies.

Energy's Run

The stakes are high.

Energy-focused stock funds' average gain of 55.55% over the past 12 months more than tripled the 17.85% average gain by all income-oriented stock mutual funds in that span. And their 4.56% 12-month yield more than doubled the 1.87% average yield of income-oriented stock funds.

Many funds categorized as growth & income had zero or little yield in that year.

Reflecting the outperformance and excess yield of energy-focused funds in the past 12 months, the bulk of all top-performing income-oriented stock funds were energy sector funds or energy-focused master limited partnership ( MLP ) funds. The latter invest in MLPs whose business tends to be running energy pipeline companies.

There is a similar predominance of energy funds when you look at just portfolios with $100 million or more in assets.

The Pros' Outlooks

Among the top holdings in Wehbe's fund are oil and gas field services companies Schlumberger ( SLB ) and Halliburton (HAL). Wehbe, who did not discuss individual names, said, "Field services stand out uniquely (in the energy space)." There is little new need for large extraction equipment, he says. There is greater need for services and small equipment.

"Tightness will come from the short-cycle consumables business," he added. "We mean valves and measurement tools, things from something like a hardware store for the oil patch."

Schlumberger and Halliburton have modest Composite Ratings of 50 and 55 from IBD. Their dividend yields are 2.3% and 1.3%.

An energy infrastructure MLP that Hatfield likes is Apache (APA). "If we are correct about the oil markets (surging in per-barrel price to nearly 70), energy stocks and energy infrastructure MLPs are very likely to outperform the market," he said. "We like Apache, which trades at a reasonable multiple of 2017 Ebitda, has exposure to the attractive Permian basin and has been discussed as a potential takeover candidate."

Its Composite Rating from IBD is a weak 43.

Aylesworth, who focuses mainly on natural gas distributors, says there has been a lot of consolidation in the local distribution company (LDC) market. Nova Scotia-based Emera completed its acquisition of Tampa, Fla.-based TECO Energy last July. "M&A activity in that space will continue," Aylesworth said. "The acquirers keep getting stronger."

For Emera, that takeover boosted its exposure to rate-regulated markets, which provides stability to revenue and earnings. At the same time, it provides Emera entry to a growing market.

Trading around 46, the stock is 8% below its July 7 high.

Aylesworth also likes Tulsa-based ONE Gas (OGS), which he describes as a local distributor in regulated markets. He likes the fact that the company has an expanding footprint in communities that are growing in Kansas, Oklahoma and Texas. Last week the utility raised its quarterly dividend by 7 cents per share to 42 cents, resulting in a $1.68 per share dividend and a yield of 2.7%.

Like Atmos Energy (ATO), another local distribution pure play, "these companies are pretty fully valued, but earnings will continue to grow," he said. "They're good mom-and-pop investments."

ONE Gas has a weak 54 Comp Rating. It has bounced off its 10- and 40-week moving averages. Trading around 64, it is not far from its all-time high above 67 in July. Atmos, with a weak 59 Comp Rating, is also trying to stay above its short- and long-term moving averages. Trading around 75, it's not far from last July's high near 82.

Calgary-based TransCanada (TRP) and Enbridge (ENB) both operate major long-distance energy pipeline networks. TransCanada's network extends from Canada into Mexico. Enbridge's extends east and west as well as north-south. In long-distance pipelines, "these are these are the big kahunas," Aylesworth said. "They have good balance sheets and histories of increasing dividends."

TransCanada has a so-so Comp Rating of 75. Its dividend yield is 3.6%. Enbridge's is 3.7%. It has a weak 46 Comp Rating. Both are trading near their September highs.

[ibdchart symbol="trp" type="daily" size="full" position="leftchart" ]

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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