Wall Street investment bank Goldman Sachs has advised investors to buy energy and mining stocks, saying the two sectors are positioned to benefit from economic growth in China. GS’ commodities strategist has forecast that Brent and WTI crude oil will climb 23% and trade near $100 and $95 per barrel over the next 12 trading months, an outlook that supports their upside view for profits in the energy sector.
"Energy trades at a discounted valuation and remains our preferred cyclical overweight.We also recommend investors own mining stocks, which are levered to China growth through rising metals prices," the investment bank stated in a note to clients.
Regarding the mining sector, Goldman has noted that China accounts for roughly 50% of the worldwide demand for industrial metals including aluminum and copper, and says China’s economic growth and metals will stand to ride higher.
Meanwhile, GS has advised investors to give home builders a wide berth as recent mixed economic data, along with the stress in the banking segment, have muddied the forecast for economic growth in the U.S. Goldman has also downgraded Consumer Durables & Apparel to Neutral.
Goldman’s bullish note on the energy sector might seem ill-timed considering it’s coming at a time when the sector appears to have lost its forward momentum. Recent optimism regarding OPEC+ production cuts has failed to counter worries about demand linked to a weakening economic backdrop and a hawkish Federal Reserve leading to oil prices remaining range-bound. Further, there are reports that Russian crude shipments remain strong despite sanctions and embargoes: Reuters reported April oil loadings from Russia's western ports are on track to reach their highest since 2019 at more than 2.4M bbl/day.
Still, there are several reasons why the bulls could still carry the day. Here are a few.
#1. Cheap Valuations Last year, the energy sector turned on the afterburners and managed to top all sectors as the global energy crisis exacerbated by Russia’s war in Ukraine triggered a big oil price rally. The sector has been more subdued in the current year with investors once again flocking to Big Tech and semiconductors. But the surprising finding is that energy stocks remain real cheap, both by absolute and historical standards.
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Indeed, the energy sector is the cheapest of all 11 U.S. market sectors, with a current PE ratio of 6.7. In comparison, the next cheapest sector is Basic Materials with a PE valuation of 10.6 while Financials is third cheapest at a PE value of 14.1 . For some perspective, the S&P 500 average PE ratio currently sits at 22.2. So, we can see that oil and gas stocks remain dirt cheap even after last year’s massive runup, thanks in large part to years of underperformance.
Rosenberg has analyzed PE ratios by energy stocks by looking at historical data since 1990 and found that, on average, the sector ranks in just its 27th percentile historically. In contrast, the S&P 500 sits in its 71st percentile despite last year’s deep selloff.
#2. Robust Earnings
It’s still early innings into the earnings season but this is already shaping up as a disappointing season. According to FactSet data,~20% of S&P 500 companies have reported Q1 2023 earrings, with their blended earnings decline clocking in at -6.2%, marking the largest earnings decline reported by the index since Q2 2020 (-31.6%).
The energy sector is, however, proving to be a different animal altogether: only three sectors are reporting improved net margins led by the Energy (11.8% vs. 10.4%) and Consumer Discretionary (6.0% vs. 4.7%) sectors while eight sectors are reporting a year-over-year decrease in their net profit margins in Q1 2023 compared to Q1 2022, led by the Materials (9.8% vs. 13.8%) sector.
Even better, the outlook for the energy sector remains bright. According to a Moody's research report, industry earnings will stabilize overall in 2023, though they will come in slightly below levels reached in 2022.
The analysts note that commodity prices have declined from very high levels earlier in 2022, but have predicted that prices are likely to remain cyclically strong through 2023. This, combined with modest growth in volumes, will support strong cash flow generation for oil and gas producers. Moody’s estimates that the U.S. energy sector’s EBITDA for 2022 will clock in at $$623B but fall to $585B in 2023.
The analysts say that low capex, rising uncertainty about the expansion of future supplies and high geopolitical risk premium will, however, continue to support cyclically high oil prices.
In other words, there simply aren’t better places for people investing in the U.S. stock market to park their money if they are looking for serious earnings growth.
Whereas oil and gas prices have declined from recent highs, they are still much higher than they have been over the past couple of years hence the ongoing enthusiasm in the energy markets. Indeed, the energy sector remains a huge Wall Street favorite, with the Zacks Oils and Energy sector being the top-ranked sector out of all 16 Zacks Ranked Sectors.
#3. Market Deficit
Oil prices have only been treading water since the big initial gains from the shock announcement, with concerns regarding global demand and recession risks continuing to weigh down the oil markets. Indeed, oil prices barely budged even after EIA data has shown that U.S. crude stockpiles have been falling while Saudi Arabia will hike its official selling prices for all oil sales to Asian customers starting May.
But StanChart has predicted that the OPEC+ cuts will eventually eliminate the surplus that had built up in the global oil markets. According to the analysts, a large oil surplus started building in late 2022 and spilled over into the first quarter of the current year. The analysts estimate that current oil inventories are 200 million barrels higher than at the start of 2022 and a good 268 million barrels higher than the June 2022 minimum.
However, they are now optimistic that the build over the past two quarters will be gone by November if cuts are maintained all year. In a slightly less bullish scenario, the same will be achieved by the end of the year if the current cuts are reversed around October.
By Alex Kimani for Oilprice.com
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