Friday, January 30, 2015

Charting the Divergence Between Oil and Energy Sector Equities

It's too early for the equities.
March WTI $45.15 up 0.62; XLE $74.26 down 0.85%; XOP $44.88 down 0.64%.
From Hard Assets Investor:

Despite Oil Price Collapse, Valuation Of Energy Stocks Surge 
A rebound in oil and natural gas is already priced into shares.

“The plunge in crude oil and natural gas prices has spurred a sell-off in energy stocks, making it a good time to buy the beaten-down sector.”

That's the thesis that many investors are embracing, with billions of dollars flowing into oil and gas stocks and exchange-traded funds in recent weeks. Nearly $10 billion has flowed into energy-related ETFs since late November.

But are energy stocks really a bargain, or is there more downside to come? A look at the sector earnings reveals that energy companies are actually trading at their most lofty valuation in years, a reflection of investors' expectations that the drop in oil prices will be short-lived.

Not Falling As Fast As Oil
While oil's decline has been swift and relentless since peaking above $107 in mid-June, the decline in oil stocks hasn't been as nearly as dramatic. In that period, WTI crude oil, the U.S. benchmark, has fallen 58 percent, while the energy sector within the S&P 500 has shed about 24 percent.

Oil Performance Since Peak

Some of the divergence can be attributed to the fact that the S&P energy sector is heavily weighted in integrated oil giants. Big Oil like Exxon Mobile and Chevron are conceivably benefiting from oil's slide in their downstream (refining) operations at the same time their oil-price-dependent upstream (exploration and production) operations suffer.

But that's certainly not the whole explanation. Exxon's earnings-per-share estimate for 2015, for example, has fallen from nearly $8 in August to $4.32 today, a decline of 46 percent. Analysts have been slashing earnings estimates for energy companies left and right, yet they are still using price decks well above the current market.

The analyst estimate consensus for WTI crude oil prices is $62 for 2015 and $75 for 2016, down from $94 for both years just three months ago, but above current prices near $44. At the same time, analysts have sliced their natural gas price estimates to $3.71 for 2015 and to $4 for 2016, down from a few months ago, but well above current prices near $2.70/mmbtu.

Oil Rebound Already Priced In
Yet even at analysts' price deck of $62 for oil and $3.71 for natural gas, energy stocks are trading at their highest valuation since 2002. Based on current 2015 estimates, the sector has a forward price-to-earnings ratio of more than 23. That compares with the 10-year average of 12.3....MORE