James Butterfill
Executive Director – Head of Research and Investment Strategy
Investments may go up or down in value and you may lose some or all of the amount invested. Past performance does not guarantee future results.
19 April 2017
ETF Securities Equity Research: Energy equities starting to look interesting
Summary
The Energy sector’s performance has lagged the recovery in oil prices
Energy sector valuations have already priced in a more
bearish outlook for oil despite some supports in the near-
term
On consensus forecasts, Energy now has the highest
dividend yield of any cyclical sector, and the highest EPS
growth over the next three years.
Energy balance sheets are now much healthier limiting
credit risks from a lower-for-longer oil price scenario.
Energy equities have lagged the recovery in oil prices
While oil prices corrected 13% in March and have since risen
8% to nearly their pre-correction levels, the interesting thing is
that oil-related equities have lagged and have risen only 2%
versus global equities.
Some near-term supports for the oil price
We are not bullish on the oil price – we continue to see it range
bound in the medium-term. Compliance issues among OPEC
are likely to cap the upside, while US shale production could
exert downside pressures. Nevertheless, there are some
counter-balancing supports in the near-term:
First, Oil positioning looks more balanced now. Since we
pointed out that speculative long positions in oil were at an
extreme at the end of February, they have since come down
and look more balanced, removing some downside risk for
further forced selling.
Second, we are entering a seasonally favourable time of the
year for oil prices – on average over the last 10 years, the oil
price has tended to rise from March to August. The closure of
refiners for maintenance during this period and the start of the
‘driving season’ in the US tend to be the main supports.
Third, global demand conditions continue to look robust even
in the face of rising supply risks from shale and OPEC
40
42
44
46
48
50
52
54
56
58
60
95
97
99
101
103
105
107
109
111
2016 2016 2016 2016 2016 2016 2016 2016 2017 2017 2017
Energy Sector has lagged the oil price recovery
Source: Bloomberg, ETF Securities as of close 18 April 2017
MSCI World Energy / MSCI World
Brent Crude (RHS)
200,000
300,000
400,000
500,000
600,000
700,000
800,000
900,000
1,000,000
Ap
r-16
Ma
y-1
6
Ju
n-1
6
Au
g-1
6
Se
p-1
6
Oct
-16
De
c-16
Ja
n-1
7
Feb
-17
Ma
r-17
CFTC Net Speculative Positioning
Source: Bloomberg, ETF Securities as of close 18 April 2017
WTI
Brent
-25
-20
-15
-10
-5
0
5
10
15
20
DE
C
NO
V
OC
T
SE
P
AU
G
JU
L
JU
N
MA
Y
AP
R
MA
R
FE
B
Average 10 yr Brent Crude price perf (%)
Source: Bloomberg, ETF Securities as of close 13 April 2017
10 yr avg
2017
Yo
Y %
2 ETF Securities Research 2016
producers.
Energy sector valuations have already priced in a more bearish outlook for oil
Based on a range of valuation metrics, energy equities have
already priced in a lower-for-longer outlook for oil. The Price-
to-Book and Dividend Yield ratios relative to the wider market
are both trading one standard deviation cheap to their long-term
average. The Energy sector has the highest forecasted dividend
yield (3.6%) among cyclical sectors and higher than the overall
market (2.6%).
Valuations compared to other reflationary beneficiaries such as
Materials and Industrials are close to an all-time extreme. The
MSCI World Energy sector is trading on a 20% discount to the
Materials sector and 40% to Industrials on Price-to-Book.
Energy should benefit if the rotation in value / reflationary
beneficiaries continues.
The sector looks less attractive on P/E as earnings are still
recovering. However, on a 3-year outlook, the Energy Sector is
forecasted have the strongest EPS growth of any sector on
consensus projections.
Energy Sector balance sheets healthier now
What is worthy to note is that the Energy sector credit risk is
much lower than 3 years ago: the recent dip in oil prices has not
caused high yield energy spreads to blow out because global oil
companies have been through a period of unprecedented cost
and capex cuts. According to IHS Markit, upstream capital
expenditure and operational costs in North America have fallen
by 50% in 2015 and 35% in 2016, their fastest rate for the last 30
years. This has helped the sector’s projected FCF yield to move
back into positive territory for the first time in three years and
should help solidify companies’ dividend pay-out policies going
forward.
What are the risks?
One of the biggest risks to oil prices in the medium-term is
deteriorating compliance among OPEC members. The cartel is
only 83% of the way to cutting the 1.2mn barrels proposed last
year. Extending the deal could be difficult given that non-OPEC
countries are doing far worse on compliance. We should get an
update at the next OPEC meeting on 25th May.
45
47
49
51
53
55
57
59
61
30
40
50
60
70
80
90
100
110
120
2010 2010 2011 2012 2012 2013 2013 2014 2014 2015 2016 2016
Global demand indicators remain firm
Source: Bloomberg, ETF Securities as of close 18 April 2017
ISM Manuf (LHS)
Brent Crude (RHS)
0.6
0.7
0.8
0.9
1
1.1
1.2
1.3
1.4
1.5
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Energy sector trading 1 st dev cheap to global equities on P/BV
Source: Bloomberg, ETF Securities as of close 18 April 2017
Energy P/BV Rel
+1 St Dev
Avg
-1 St Dev
-10 -5 0 5 10 15 20 25 30 35
Energy
Materials
info Tech
MSCI World
Cons Staps
Telecoms
Health Care
Real Estate
Cons Disc
Financials
Utilities
Industrials
Energy has the higest forecasted EPS growth over the next 3 years
Source: Bloomberg, ETF Securities as of close 17 April 2017
3yr EPS CAGR
-4
-2
0
2
4
6
8
10
12
14
16
18
2007 2008 2009 2010 2010 2011 2012 2013 2013 2014 2015 2016 2016
Energy company balance sheets have started to repair
Source: Bloomberg, ETF Securities as of close 17 April 2017
MSCI World Energy 12m Fwd FCF Yld
3 ETF Securities Research 2016
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