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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Where To Find Value In Today’s Energy Markets

Rig

The easy money in the oil market bounce back has been made in the U.S. Oil stocks in the U.S. have largely soared since the start of the year, even with oil prices having only bounced back to the $40-50 range. While firms like Devon, Continental, and Apache will all move higher if oil prices keep moving higher, that is a major question in the markets right now.

Oil prices have essentially been range bound for several months, and it’s unclear what it would take to move prices higher. Short of drastic action from OPEC, oil may not have much more upside from here. None of this means that there aren’t still good opportunities for investors in the energy space though. While nearly every other broad sector of the market looks fully valued, energy stocks remain relatively inexpensive on a CAPE basis. Still, relying on CAPE to pick stocks has not traditionally been a winning strategy.

Investors looking for a little bit more diversification, risk-reduction, and potential upside might consider looking abroad. In particular, Canadian and Russian stocks still look very cheap, especially in the energy sector. Now of course most investors cannot directly invest in these firms, but there are multiple good ETF options available to all U.S. investors today.

Take EWC, the iShares Canada ETF for instance. The fund holds 93 different Canadian stocks and has a heavy weight towards energy and financial companies. Among the top 10 holdings of the fund are Suncor Energy (4.05 percent weighting), Enbridge (3.40 percent weighting). Canada Natural Resources (2.96 percent), and TransCanada (2.81 percent). EWC as a whole has a 22 percent weighting on energy stocks and an additional 12 percent weighting on materials. For investors then, it’s a good way to get broad exposure to the still cheap Canadian materials and energy sectors.

The normal argument against ETFs is that it leaves investors unable to pick and choose which stocks from a basket they want (though options or individual securities trades can be used to rectify that). That option is a moot point for foreign companies and most investors – the only way most investors can get access to many foreign firms is through ETFs. While some foreign firms, especially Canadian ones will have U.S. ADRs, most of EWCs 93 firms can only be accessed through the ETF.

Related: What If The Oil Rebound Never Happens?

EWC is only one of the many Canadian ETFs available to investors, and investors would be wise to do their own due diligence to find the right vehicle offering appropriate exposure for their personal situation. While the fund is a reasonable choice in part due to a cheap 48 bps expense ratio, a 2 percent dividend yield, and assets under management of about $2.8B (which minimizes risks of the fund being shuttered), EWC is not going to be a good investment choice for everyone.

Instead, the broader point is that with U.S. options looking limited, Sage investors should seek opportunities abroad. Russia is another choice that looks interesting at present levels. The Russian economy is heavily dependent on oil, but production costs are extraordinarily low. Russian energy firms would be among the last standing even if oil prices retrace their path lower and stay low over time. Russian stocks as a whole have been hindered by the perception of political risks in the country, but in its own peculiar way, Russia is more stable than it has been in a long time. The country is firmly under the control of Putin who is looking more conciliatory at this stage thanks to the humbling experience of prolonged low oil prices. The Ukraine and Syria situations are still tenuous, but they appear to have reached a tentative equilibrium of instability. Of course, Russia is a market that requires a higher willingness to take on risk, but overall the country stacks up well on a number of key metrics.

In general then, investors looking for value amongst in a robust market might consider going where others will not.

By Michael McDonald of Oilprice.com

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