Energy stocks are a big buy right now

Oil prices rose on Monday morning after OPEC+ decided on Sunday to maintain the course of cutting oil production before applying a price cap of $60 on crude oil of Russian origin agreed by the EU, the G7 and Australia. OPEC+ previously agreed to cut output by two million barrels a day, about two percent of global demand, from November until the end of 2023.

Still, oil prices are down more than 30% from their 52-week highs, while, curiously, the energy sector is within just four percent of its peak. Indeed, over the past two months, the leading benchmark in the energy sector, the Energy Select Sector SPDR Fund (NYSEARCA: XLE ), is up 34%, while average spot crude oil prices are down 18%. This is a remarkable divergence, as the correlation between the two over the past five years is 77% and 69% over the past decade.

According to Bespoke Investment Group via the Wall Street Journal, the current division marked the first time since 2006 that the oil and gas sector traded within 3% of a 52-week high, while the price of WTI retreated more than 25% from its corresponding 52-week high. It is also only the fifth such divergence since 1990.

David Rosenberg, founder of an independent research firm Rosenberg Research & Associates Inc, outlined 5 key reasons why energy stocks remain a buy even though oil prices have failed to make significant gains over the past few months.

#1. Favorable ratings

Energy stocks remain cheap despite huge growth. Not only has the sector significantly outperformed the market, but companies in the sector remain relatively cheap, undervalued and come in with above-average forecast earnings growth.

Rosenberg analyzed energy stock PE ratios by looking at historical data since 1990 and found that, on average, the sector only ranks in its 27th percentile historically. Unlike them, S&P 500 sits in its 71st percentile despite the deep selloff that occurred earlier in the year.

Image source: Zacks Investment Research

Some of the cheapest oil and gas stocks right now include Ovintiv Inc. (NYSE: OVV ) with a PE ratio of 6.09; Civitas Resources, Inc. (NYSE: CIVI ) with a PE ratio of 4.87, Enerplus Corporation (NYSE: ERF ) (TSX: ERF ) has a PE ratio of 5.80, Occidental Petroleum Corporation (NYSE: OXY ) has a PE ratio of 7.09 while Canadian Natural Resources Limited (NYSE: CNQ ) has a PE ratio of 6.79.

#2. Steady earnings

Strong earnings from energy companies are a big reason why investors are still flocking to oil stocks.

The third quarter earnings season is almost over, but so far it’s shaping up to be better than expected. According to FactSet Earnings Insightsfor the third quarter of 2022, 94% of S&P 500 companies reported earnings for the third quarter of 2022, of which 69% reported a positive EPS surprise and 71% reported a positive revenue surprise.

The energy sector posted the highest earnings growth of all eleven sectors at 137.3% versus 2.2% on average for S&P 500. At the subsector level, all five sub-industries within the sector reported year-over-year revenue increases: Oil & Gas Refining & Marketing (302%), Integrated Oil & Gas (138%), Oil & Gas Exploration & Production (107%), Equipment & Services for oil and gas (91%) and Storage and transportation of oil and gas (21%). Energy is also the sector with the most companies beating Wall Street estimates by 81%. Positive revenue surprises were reported by Marathon Petroleum ($47.2 billion vs. $35.8 billion), Exxon Mobil ($112.1 billion vs. $104.6 billion), Chevron ($66.6 billion vs. $57.4 billion dollars), Valero Energy ($42.3 billion vs. $40.1 billion) and Phillips 66 ($43.4 billion vs. $39.3 billion) contributed significantly to the increase in the index’s earnings growth rate since September 30 .

Even better, the outlook for the energy sector remains good. According to a recent Moody’s Research Reportindustry profits will stabilize overall in 2023, although they will be slightly below the levels reached at recent highs.

Analysts note that commodity prices have declined from very high levels earlier in 2022, but forecast that prices are likely to remain cyclically strong in 2023. This, combined with modest volume growth, will help generate strong cash flow. flows for oil and gas producers. Moody’s estimates that US energy sector EBITDA will reach $623 billion in 2022, but will fall to $585 billion in 2023.

Analysts say low capital costs, growing uncertainty about future supply expansion and a high geopolitical risk premium, however, will continue to support cyclically high oil prices. Meanwhile, strong US LNG export demand will continue to support high natural gas prices.

In other words, there simply aren’t better places for people investing in the US stock market to park their money if they’re looking for serious income growth. Furthermore, the outlook for the sector remains good.

Although oil and gas prices have come down from recent highs, they are still much higher than they have been in the past few years, hence the continued enthusiasm in the energy markets. Indeed, the energy sector remains a huge favorite on Wall Street, with the Zacks Oils and Energy sector being the highest-ranked sector of all 16 Zacks Ranked sectors.

#3. Strong payouts to shareholders

Over the past two years, U.S. energy companies have shifted from using most of their cash flow to grow production to returning more cash to shareholders through dividends and buybacks.

Consequently, the combined dividend and buyback yield for the energy sector now approaches 8%, which is high by historical standards. Rosenberg notes that similar elevated levels occurred in 2020 and 2009, which preceded periods of strength. By comparison, the combined dividend and buyback yield for the S&P 500 is closer to five percent, making for one of the largest shortfalls in favor of the energy sector in history.

#4. Low inventory

Despite weak demand, U.S. inventory levels are at their lowest level since the mid-2000s, even as the Biden administration tries to lower prices by flooding markets with 180 million barrels of SPR crude. Rosenberg notes that other potential catalysts that could lead to additional upward pressure on prices include a cap on Russian oil prices, a further escalation in the Russia/Ukraine war, and China moving away from its zero-covid-19 policy. 19.

#5. Higher embedded ‘OPEC+ put’

Rosenberg points out that OPEC+ is now more comfortable trading oil above $90 a barrel, as opposed to the $60-$70 range they have accepted in recent years. The energy expert says this is because the cartel is less concerned about losing market share to US shale producers as the latter have prioritized shareholder payouts over aggressive production growth.

OPEC+’s new stance offers better visibility and predictability for oil prices, while prices in the $90-per-barrel range can support strong payouts through dividends and buybacks.

By Alex Kimani for Oilprice.com

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