24 Aug

Do US Energy Stocks Look Promising?

WRITTEN BY Rekha Khandelwal, CFA

US energy stocks are currently the most undervalued of all the S&P 500 sectors. In 2019, the Energy Select Sector SPDR ETF (XLE), that represents the S&P 500 energy stocks, has risen around 2%. By comparison, the S&P 500 Index has risen by 16%. In five years, XLE fell roughly 40% while the S&P 500 Index (SPY) has risen around 45% over the same timeframe. Energy sector stocks continue to face an uncertain outlook amidst the US-China trade war and its current and potential impacts on crude oil prices.

Do US Energy Stocks Look Promising?

The above graph shows the calculated sectoral PE (price-to-earnings) ratios. The stocks in the energy sector are trading at an average PE of 13.5 compared to a market PE of approximately 20x. USO (US Oil Fund) and natural gas prices tend to impact the performance of energy companies in the long term. Moreover, the oil price movements tend to drive investors’ sentiments, which impacts the energy stocks’ prices. Crude oil prices are up roughly 20% so far in 2019.

Not all energy stocks are the same

Energy stocks are generally categorized as upstream, midstream, and downstream stocks. The upstream segment includes oil and gas exploration and production companies that bring the commodities out from under the ground. ConocoPhillips (COP), EOG Resources (EOG), and Apache (APA) are some of the top upstream companies. Oilfield services companies like Schlumberger (SLB) and Halliburton (HAL) provide services to the upstream energy companies.

In comparison, the midstream companies process and then transport the extracted hydrocarbons through pipelines. Some of the top midstream companies include Kinder Morgan (KMI), Enterprise Products Partners (EPD), and ONEOK (OKE). Downstream processes include refining and distribution of petroleum and gas products to retail outlets and end customers. Companies operating in this value chain include Phillips 66 (PSX), HollyFrontier Corp. (HFC), etc.

Integrated energy companies like ExxonMobil (XOM) and Chevron Corp. (CVX) operate across all the three segments—upstream, midstream, and downstream. The S&P 500 Index includes 28 energy stocks.

Midstream companies lead the gains

So far in 2019, the midstream energy stocks have outperformed other US energy stocks. The AMLP ETF (Alerian MLP), an ETF of top energy infrastructure MLPs, is up roughly 4%. The midstream companies are less vulnerable to oil and gas prices as compared to other segments of the energy sector. This is because a significant portion of their earnings come from fixed-price contracts to transport hydrocarbons.

Capital and financial indiscipline really impacted most of the midstream stocks after commodities prices rationalized a few years back. The segment saw consolidation as well as changes in a structure from the once-popular MLP structure. Companies focused on strengthening balance sheets through debt and capital management. One such example is Kinder Morgan (KMI). Kinder Morgan is up roughly 31% in 2019. This US energy stock has come a long way from its dividend cut back in 2015. Kinder Morgan has significantly reduced its leverage.

Do US Energy Stocks Look Promising?

The above graph shows Kinder Morgan’s leverage, as measured by its net-debt-to-adjusted-EBITDA ratio. The company recently sold some assets to further reduce its leverage.

Upstream stocks struggle

The upstream segment is more directly exposed to the commodity prices as well as demand and supply dynamics. The SPDR S&P Oil & Gas Exploration & Production ETF (XOP) has fallen roughly 18% in 2019. ConocoPhillips (COP), EOG Resources (EOG), and Apache (APA) are each down more than 13% in 2019.

Obviously, oilfield services stocks, which provide services to the exploration and production companies, aren’t doing well either. The SPDR S&P Oil & Gas Equipment & Services ETF (XES) is down roughly 20% year-to-date. Halliburton has fallen roughly 30% while Schlumberger is down around 7% in 2019. In comparison, the VanEck Vectors Oil Refiners ETF (CRAK) is down roughly 3% year-to-date. The SPDR S&P 500 ETF (SPY) is up roughly 16%.

ExxonMobil: a top energy stock

Integrated energy companies have an advantage over other players in the energy sector. Diversified operations protect them to some extent from any trend that might impact one particular segment of the energy value chain.

Among the integrated US energy stocks, ExxonMobil (XOM) is up 2% in 2019, underperforming the broader markets by a huge margin. With a market capitalization of approximately $294 billion, ExxonMobil is the largest S&P 500 energy sector stock. The stock is trading at a PE of slightly below 17x. Though that’s higher than the sector’s average, the stock has historically traded at a premium compared to its peers. ExxonMobil looks the most attractive among its integrated peers based on its expected earnings growth and balance sheet strength. Moreover, ExxonMobil stock is trading at an attractive yield of approximately 5%.

Do energy stocks look promising?

According to the US Energy Information Administration, the United States surpassed Saudi Arabia to become the largest crude oil producer in 2018. Crude oil production continues to rise, and oil prices continue to largely sustain above $50. Despite that, US energy stocks aren’t getting investors’ interest. Currently, the rewards in the energy sector seem to outweigh the risks.

For the latest updates on energy stocks, check out Market Realist’s Energy and Utilities page.

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