Eye On Energy

10/10/2011


Earnings estimates have been shrinking as the evenings grow shorter, and the days of easy year-to-year comparisons seem as distant as the summer sun. 

As of Oct. 3, 84 components of the S&P 500 Index had warned of lower-than-expected earnings for the September quarter, representing 68% of all preannouncements. At the same time a year ago, there had been fewer warnings (77) for the September 2010 quarter, accounting for only 59% of preannouncements. In the past couple of weeks, profit warnings came from FedEx ($68; FDX), slowed by weak volumes of consumer electronics coming from Asia, and Nucor ($32; NUE), hurt by depressed prices for steel despite stronger demand from several key end markets. Other bellwethers such as General Electric ($15; GE), Ford Motor ($10; F), UPS ($64; UPS), and AT&T ($28; T) see a continuation of the muted recovery but are quick to add that they don't anticipate a double-dip recession.

Blame the malaise, at least in part, on the usual suspects: high unemployment, a weak housing market, consumers' lack of confidence in the future, and Europe's financial mess.

ENERGY SETS GROWTH PACE — FOR NOW
Consensus estimates project the S&P 500 Energy Sector will deliver per-share-profit growth of 37% this year and 8% in 2012. Wall Street expects energy to be one of the two strongest-growing sectors this year but toward the bottom of the pack next year.
Estimated Year-To-Year Profit Growth
Sector
3rd Qtr.
2011
(%)
4th Qtr.
2011
(%)
1st Qtr.
2012
(%)
2nd Qtr.
2012
(%)
Calendar
2011
(%)
Calendar
2012
(%)
Consumer Discretionary
19
14
11
9
16
14
Consumer Staples
8
8
8
8
10
10
Energy
49
29
17
4
37
8
Financials
4
27
15
90
2
31
Health Care
4
6
2
3
7
6
Industrials
15
14
16
13
20
16
Materials
35
26
15
15
43
13
Technology
9
10
8
6
17
10
Telecom
7
5
7
1
1
14
Utilities
(3)
4
(7)
(14)
(2)
0
S&P 500 Index
13
15
10
14
14
13
Source: Thomson Reuters.

One area to watch, especially in the next few months, is the energy sector. Declines in energy prices have contributed to reduced profit estimates. Since peaking near $100 in Late July, West Texas Intermediate crude oil has fallen 24% to $75.67 per barrel, the lowest price in more than a year.

Natural-gas prices, down 22% from mid-July highs to $3.64 per thousand cubic feet, have not averaged more than $4.26 in any month since February 2010. Relative to oil prices, natural gas has been depressed for several years. While oil remains about 48% below its 2008 highs, natural-gas has spent most of 2011 at less than one-third of its 2008 peak level. With supplies high and demand modest, prices could remain low for some time.

Energy is projected to deliver stronger earnings growth than any other sector in the December and March quarters. The S&P 500 Energy Sector Index's earnings are expected to be up 29% in the December quarter and 18% in the March quarter.

That rosy picture is reflected in Quadrix, with energy stocks in the S&P 1500 Index averaging a Momentum score of 59, the highest of any sector. However, the sector's average Earnings Estimates score, which reflects estimate-revision trends, is just 42.

Investors should proceed with caution, as energy stocks are irrevocably linked to commodity prices. The sector's profit growth is projected to slow to 8% in 2012. That slowdown suggests expectations for minimal growth in oil prices and no major rebound in natural gas. 

Our top selections in the energy sector are Exxon Mobil ($73; XOM) and Chevron ($91; CVX). Both companies have strong operating momentum and aggressive long-range projects that should boost production over the next decade. Exxon continues to expand its shale operations in the U.S., while Chevron has a big part of more than $60 billion in liquefied natural gas projects off the coast of Australia.

Both industry leaders are attractively valued, trading at discounts of at least 17% to their respective five-year average price/earnings ratios. Exxon Mobil is a Focus List Buy and a Long-Term Buy. Chevron is a Buy and a Long-Term Buy.


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