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Big energy names will soon make their way into the earnings season spotlight as leading firms from the sector start reporting quarterly results near the end of this month.
Aside from the earnings results, investors will also be tuning into this corner of the market given the volatile nature of crude oil; following an encouraging 3-month rebound, crude oil prices are once again re-testing the $50 level (is $45 next?) which puts extra pressure on energy earnings.
The Contrarian Case
It’s incredibly difficult to muster up the conviction to invest where there’s a recent history of steep losses – in this case, the oil & gas industry. Since peaking in late June of 2014, energy stocks and crude oil prices have endured a sharp downturn. After an encouraging rebound at the start of 2015, oil names and oil futures are down in the dumps again.
What has changed? That’s a really broad (and arguably impossible) question to answer. More realistically, what we should be asking in the context of earnings season is, how have expectations changed relative to price performance?
That’s no easy question to answer either, but luckily the folks at FactSet offer industry-leading earnings insights and this just so happens to be included in their regular analysis:
The Energy sector (purple dot) should jump out at you for two reasons. First and foremost, looking along the horizontal axis, this is clearly the worst performing sector from the group. Second, looking along the vertical axis, we see that changes in EPS are either flat or slightly positive for the energy sector. The divergence between price performance (in this case negative) and changes in fundamentals (in this case largely unchanged) is exactly where a true contrarian sees great opportunity.
Let’s recap. Since June 30th, the energy sector has seen its forward 12-month EPS remain largely unchanged, while at the same time its price has declined upwards of 4% (as represented by XLE as of 7/20/2015). If this value opportunity intrigues you, read on below as we take a look at specific trading options.
Which Energy ETFs to Consider
The energy sector is expected to report the largest year-over-year decline in earnings (-55.4%) of all ten sectors. Digging deeper, four of the seven sub-industries are reporting or are projected to report a year-over-year drop in earnings. According to FactSet, Oil & Gas Exploration & Production (-108%), Oil & Gas Drilling (-55%), Oil & Gas Equipment & Services (-53%), and Integrated Oil & Gas (-50%) firms are projected to post steep declines. Some fund types to play these names include:
- Broad Energy ETFs
- Oil & Gas Exploration & Production ETFs
- Oil Equipment & Services
- Unconventional Oil & Gas
On the other end of the spectrum, we might see more upbeat results from the Oil & Gas Refining & Marketing (41%), Oil & Gas Storage & Transportation (12%), and Coal & Consumable Fuels (7%) companies. Some fund types to play these names include:
The Bottom Line
The energy sector warrants a closer look from contrarian investors looking to take advantage of a beaten down corner of the market. No matter what your outlook may be, whether you’re buying or selling an ETP, it’s vital to remember two critical pieces of advice; first, always trade using limit orders. Lastly, remember to utilize a stop-loss order especially if you’re shorting an ETF or utilizing leverage in any way.
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