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Alex Kimani is a veteran finance writer, investor, engineer and researcher for Safehaven.com. 

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Oil Stocks Are Increasingly Disconnected From Prices

  • Energy stocks remain cheap despite the huge runup this year.
  • Oil stocks have continued to show a clear disconnect from the commodity they track.
  • The energy sector is reporting the greatest increase in net profit margin compared to the 5-year average.
Wall St

Oil stocks have continued to show a clear disconnect from the commodity they track, with oil equities staging a powerful rally even as oil prices have fallen since the OPEC meeting. Over the past 30 days, the energy sector’s leading benchmark, the Energy Select Sector SPDR Fund (NYSEARCA: XLE), has climbed 24.6% while average crude spot prices have declined 8% over the timeframe. XLE now boasts a 52.9% return in the year-to-date compared to a 20.0% decline by the S&P 500.

There’s a method to the madness, though.

We are still in the early innings of Q3 2022 earnings season, but so far it’s shaping up to be better-than-feared. According to FactSet’s earnings insights, for Q3 2022 (with 20% of S&P 500 companies reporting actual results), 72% of S&P 500 companies have reported a positive EPS surprise and 70%  have reported a positive revenue surprise, with both figures higher than earlier projections.

The energy sector is reporting the greatest increase in net profit margin compared to the 5-year average (14.6% vs. 6.8%). 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.

Unfortunately, the energy sector is also leading in one unwanted metric: downward revisions. Downward revisions to revenue estimates by Big Oil companies including Chevron Inc. (NYSE: CVX) from $60.8 billion to $57.4 billion, ConocoPhillips (NYSE: COP) from $19.8 billion to $18.0 billion, Exxon Mobil (NYSE: XOM) from $106.0 billion to $104.6 billion, and Phillips 66 (NYSE: PSX) from $40.5 billion to $39.4 billion have been substantial contributors to the decrease in the revenue growth rate for the sector. As a result, the blended revenue growth rate for the energy sector has decreased to 32.2% from consensus projection of 35.5% just a month ago. According to analysts, most companies in the energy sector are revising their revenue and earnings estimates downwards mainly due to high volatility in the energy markets. For instance, Shell Plc (NYSE: SHEL) recently issued a weak trading update: 

Earnings estimate (US$8.2bn) is 8% below consensus and we believe the gas trading issues in Q3 could extend to 4Q if the JKM-TTF differential widens again,” Jefferies has said. JKM (Japan-Korea Marker) generally acts as a satellite price to the more liquid European benchmark TTF (Title Transfer Facility) gas hub price. JKM liquidity has evolved rapidly across the last 3 years. Growth in spot trading liquidity has seen JKM increasingly used as the basis for physical trades (both in and outside Asia) as well as increasingly a contract reference point for derivatives (e.g. JKM swaps) and even medium to longer term supply contracts.

Share Buybacks

Luckily, investors have chosen to focus on the bigger picture rather than short-term volatility. Further, earnings in the sector are likely to remain high due to high levels of share repurchases. Oil and gas supermajors are on course to repurchase their shares at near-record levels this year thanks to soaring oil and gas prices helping them to deliver bumper profits and boost returns for investors. 

According to data from Bernstein Research, the seven supermajors are poised to return $38bn to shareholders through buyback programmes this year, with investment bank RBC Capital Markets putting the total figure even higher, at $41bn. 

In 2014, when oil was trading over $100/barrel, we only saw $21 billion in buybacks. This year’s figure easily outpaces the 2008 number. 

But here’s another interesting thing: Big Oil’s capex and production have remained mostly flat despite reporting record second-quarter profits. 

Data from the U.S. Energy Information Administration (EIA) shows that Big Oil companies have mostly downshifted both capital spending and production for the second-quarter. An EIA review of 53 public U.S. gas and oil companies, responsible for about 34% of domestic production, showed a 5% decline in capital expenditures in the second-quarter vs. Q1 this year. 

Cheap Energy Stocks

Another surprising finding: energy stocks remain cheap despite the huge runup. Not only has the sector widely outperformed the market, but companies within this sector are relatively cheap, undervalued, and come with above-average projected earnings growth.


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 5.46; Civitas Resources, Inc. (NYSE: CIVI) with a PE ratio of 4.97, Enerplus Corporation (NYSE: ERF)(TSX: ERF) has  PE ratio of 5.84,  Occidental Petroleum Corporation (NYSE: OXY) has a PE ratio of 6.84 while Canadian Natural Resources Limited (NYSE: CNQ) has a PE ratio of 6.79.

By Alex Kimani for Oilprice.com

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