Energy Rallies Despite Lack Of Growth

1/30/2017


After lagging the broad S&P 1500 Index for four years, energy stocks experienced a sharp reversal in 2016. Stocks in the S&P 1500 energy sector averaged total returns of 27% in 2016 — three percentage points better than any other sector in the index. The energy sector was the worst performer in 2015 and 2014, while it finished no better than eighth in 2013 and 2012.

Energy stocks have rallied despite their lack of operating momentum. Per-share profits for S&P 1500 energy stocks have slumped an average of 25% over the past 12 months on 31% lower revenue. Even worse, about three-quarters of energy stocks reported a loss for the past 12 months, which explains the sparse collection of usable price/earnings ratios and profit-growth rates in the table below.

Predictably, the combination of rising prices and lower earnings has pushed up valuations. We excluded P/E ratios above 75 or below 0. Energy stocks average trailing P/E ratios of 25.8, up from 17.0 at the end of 2015 and the average of 21.4 since December 1994.

Admittedly, cyclical sectors can create headaches for investors. Shares often appear cheapest when operating momentum is strongest, creating the temptation for investors to pile into the sector just as earnings are peaking.

Indeed, low valuations for energy stocks don't necessarily presage strong future returns, as shown in the table below. When the average S&P 1500 energy stock has traded between 15 and 20 times trailing earnings, it has gone on to average a 12-month return of 7% — far worse than when average P/E ratios were above 20.

You'll notice that the strongest performance for energy stocks has occurred when they traded below 10 times earnings. But this only happened in the seven-month stretch from October 2008 to April 2009, when most stocks, especially cyclicals, went on to post sharp gains following the financial meltdown.

Ultimately, the direction of most energy stocks will remain intertwined with oil prices. Brent crude, the benchmark for oil prices outside of the U.S., jumped 50% last year, the strongest annual gain since 2009. Brent crude, recently about $55 per barrel, has traded above psychological barrier of $50 since the Organization of the Petroleum Exporting Countries (OPEC) pledged on Nov. 30 to trim oil production about 4%. While some investors worried OPEC had set too optimistic a target, reports have emerged that producers are already close to their cutback goal. However, U.S. production is on the rise.

QUADRIX'S MIXED PERFORMANCE FOR ENERGY STOCKS
With the exception of Earnings Estimates, our Quadrix category scores do not have a good track record for S&P 1500 energy stocks over the past decade. Quadrix has fared better in the past five years, and several individual factors have consistently outperformed.
Average 12-Month Outperformance
Last 10
Years (120
Periods)
(%)
Last 5
Year (60
Periods)
(%)
Last 1
Year (12
Periods
(%)
Monitored Energy Stocks
Currently Scoring Above 80
Quadrix categories
Momentum
(2.8)
(1.3)
(5.9)
EQM
Value
(1.0)
0.1
(11.4)
EQM
Quality
(1.1)
2.4
4.2
EQM
Financial Strength
(1.0)
0.5
6.5
EQM
Earnings Estimates
1.4
2.4
(1.6)
APC, CVX, HAL, PAA, VLO
Performance
(1.6)
2.9
0.1
APC, HAL
Overall
(3.1)
1.2
(6.0)
EQM
Effective Quadrix factors
Price/sales ratio
5.5
6.2
(2.3)
BP, PSX, PAA, VLO
Enterprise ratio
1.7
5.6
1.6
VLO
3-year equity growth
0.1
4.4
7.5
CLR, EQM, PSX, VLO
5-year equity growth
0.7
3.8
8.4
CLR, EQM, HAL, VLO, XOM
Earnings predictability
1.6
3.7
10.9
CVX, EQM, XOM
Cash flow to interest expense
2.1
6.4
8.0
CVX, EQM, XOM

For our purposes, we seek stocks that score well in Quadrix, earn decent valuations, and offer solid growth prospects. Few energy companies meet that criteria. The sector has an average Value score of 36 and Overall score of 27. Of the sector's seven industries, only refining and storage are projected to increase earnings per share over the next 12 months. Per-share profits are projected to slip 5% for the overall energy sector.

Our one energy stock recommended for purchase, EQT Midstream Partners ($78; EQM), is reviewed below. We also review Exxon Mobil ($85; XOM).

EQT Midstream Partners offers strong operating growth and a reasonable valuation at a time when neither is common in the energy sector. It has reeled off 19 straight quarters of double-digit revenue growth; no energy stock in the index has more than three consecutive quarters of growth. At 14 times trailing earnings, EQT Midstream trades 35% below its three-year average; just two energy stocks trade at a larger discount.

Earlier this month the company increased its quarterly cash distribution to $0.85 per unit, payable Feb. 14 and up 4% from the December quarter. EQT has raised its dividend in each of the past 16 quarters, helping to push its yield to 4.0%. For the December quarter, EQT is expected to report earnings per share of $1.33, up 6%, on revenue of $190 million, up 14%. Scheduled to post results on Feb. 2, the stock is a Buy and a Long-Term Buy.

 


Exxon Mobil remains a reliable provider of dividend growth, though cracks are forming that could eventually cause its reputation to crumble. Its dividend rose just 3% in 2016, the fourth straight year of lower dividend growth. Exxon currently devotes 140% of its earnings to its dividend, leaving little flexibility for future growth.

Even as oil prices rebounded in the past year, Exxon's cash-flow trends worsened. Operating cash flow fell 43% in the first nine months of 2016. Lower profits and cash flow have forced Exxon to tap the debt markets to fund its dividend. Net debt ballooned to $41.06 billion in the September quarter, compared to net cash of $837 million for the same period in 2012. Citing this cash crunch, Standard & poor's downgraded Exxon's credit rating in April, the first such move in more than 70 years. Exxon, earning an Overall score of 9, is rated C (below average).

 

COMING UP DRY
Of the 17 energy stocks we monitor, shown immediately below, we only recommend EQT Midstream Partners ($78; EQM) for purchase. Drilling into the S&P 1500 energy sector, at far bottom, we find operating growth in short supply. Given the sector's recent rally, most energy-related industries look expensive.
Stock-
Market
Value
($Bil.)
5-Year
Annual.
Dividend
Growth
(%)
Change, Last
--- 12 Months ---
Est. EPS
Change,
Next 12
Months
(%)
--- P/E Ratio ---
--------- Quadrix Scores --------
Company (Price; Ticker)
Div.
Yield
(%)
Per-
Share
Earnings
(%)
Revenue
(%)
Trailing
Forward
Momen-
tum
Value
Earns.
Ests.
Overall
Industry
Anadarko Petro.
($71; APC)
36.5
0.3
3
 NA 
(27)
NA
 NA 
 NA 
46
9
93
21
Expl.
& prod.
Apache ($61; APA)
23.3
1.6
11
 NA 
(35)
NA
 NA 
57
49
8
29
9
Expl.
& prod.
BP ($37; BP)
116.8
6.5
14
(26)
(27)
NA
 NA
 NA 
20
38
0
19
Integrated
Chevron ($117; CVX)
220.8
3.7
7
 NA 
(26)
NA
 NA 
29
11
30
42
18
Integrated
ConocoPhillips
($51; COP)
63.2
2.0
(10)
 NA 
(33)
NA
NA 
 NA 
12
32
80
20
Expl.
& prod.
Continental Res.
($52; CLR)
19.3
0.0
NA
 NA 
(41)
NA
 NA 
 NA 
12
17
56
14
Expl.
& prod.
EOG Resources
($104; EOG)
56.9
0.6
16
 NA 
(38)
NA
 NA 
 NA 
47
12
83
26
Expl.
& prod.
EQT Midstream
Part. ($78; EQM)
6.3
4.0
NA
13
18
2
14
14
73
85
48
94
Storage
Exxon Mobil
($85; XOM)
356.6
3.5
10
(55)
(25)
NA
40
23
7
23
14
9
Integrated
Halliburton
($57; HAL)
49.7
1.3
15
 NA
(33)
NA
 NA 
50
29
5
98
19
Equipment
Hess ($56; HES)
17.7
1.8
20
 NA 
(37)
(35)
 NA 
 NA 
16
25
80
18
Expl.
& prod.
National Oilwell
($40; NOV)
14.9
0.5
18
 NA 
(53)
60
 NA 
 NA 
2
35
65
15
Equipment
Occidental Petro.
($68; OXY)
52.1
4.5
12
 NA 
(28)
NA
NA 
 NA 
44
10
43
9
Integrated
Phillips 66 ($85; PSX)
44.9
3.0
NA
(53)
(30)
15
21
19
9
37
3
20
Refining
Plains All American
($31; PAA)
12.7
8.9
8
(57)
(30)
73
29
17
28
43
75
30
Storage
Schlumberger
($86; SLB)
118.9
2.3
16
(66)
(22)
54
74
48
10
11
34
11
Equipment
Valero Energy
($68; VLO)
31.4
3.5
63
(50)
(26)
7
15
14
20
76
33
55
Refining
S&P 1500 energy industries (number of companies)
Coal & consumable
fuels (2)
2.4
0.0
(45)
 NA 
(26)
NA
15
69
68
52
91
48
Integrated oil &
gas (3)
208.8
3.9
10
(55)
(26)
NA
40
26
21
21
33
12
Drilling (11)
3.2
0.5
(21)
(39)
(39)
(12)
8
35
22
60
56
43
Equipment &
services (25)
9.9
0.6
(6)
(1)
(35)
(4)
37
47
14
38
51
24
Exploration &
production (30)
13.3
0.4
(9)
 NA 
(32)
(11)
32
37
38
21
64
18
Refining &
marketing (9)
14.0
2.6
35
(46)
(20)
14
19
16
29
58
25
41
Storage &
transportation (4)
28.5
3.4
12
4
(7)
1
42
34
40
30
46
29
S&P 1500 energy
sector (84)
18.5
1.0
(4)
(25)
(31)
(3)
26
33
28
356
54
27
Notes: Quadrix scores are percentile ranks, with 100 the best. NA indicates not available. We excluded operating growth rates above 75% and below -75%, and also excluded P/E ratios above 75 and below 0.

U.S. natural-gas production remains high despite low prices

U.S. production of natural gas has slipped 4% from its peak in July 2015 but remains well above historic levels. The U.S. benchmark for natural-gas spot prices averaged $2.49 per million British thermal units (MMBtu) in 2016, says the U.S. Energy Information Administration. That's the lowest annual average price since 1999.

Natural gas prices fell below $2.00/MMBtu from February to May before rising to end the year at $3.58/MMBtu. An expanding supply of natural gas, combined with its low prices, has benefited chemical companies, utilities, and firms that make fertilizer.


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