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The hated energy sector is now back in favor with $65 crude (up about 9%) and bullish analyst comments. A host of analysts started betting big on this unloved sector. Credit Suisse analysts view the space as attractive for the first time in two years and have raised their rating to market weight from underweight.
Morgan Stanley too is placing bullish bets on energy and has an overweight rating on it. The space, measured by Energy Select Sector SPDR ETF (XLE - Free Report) (down 2.7%), outperformed the broader market denoted by SPDR S&P 500 ETF (SPY - Free Report) (down more than 4.9%) in the last one month (as of Mar 28, 2018) (read: Energy ETFs Rally: Will the Gains Last?).
Analysts believe that the winning trend in the energy space will be maintained ahead. Below we highlight the reasons behind this bullishness.
Solid Earnings Growth
Energy sector earnings are expected to be up 60.8% in the first quarter of 2018 from the year-ago period after 157.2% year-over-year earnings growth in the preceding quarter, per the Earnings Trends issued on Mar 23, 2018. Revenue growth will likely be 15.7% in Q1 after a 23.8% increase in top line in Q4.
Compelling Valuation
Credit Suisse analysts believe that extended valuations led energy stocks to underperform since mid-2016, despite a favorable operating backdrop and strong earnings. But a host of tailwinds and “weaker stock prices makes the sector's valuations more attractive than they have been in several years."
The Shiller P/E for energy sector is 18.60x, the lowest among the S&P 500 universe. The broader market index has a Shiller P/E of 31x.
Geopolitical Concerns
Geopolitical risks in the Middle East, especially the strained relationship between Saudi and Iran, can act as a key driver. The Arab coalition led by Saudi Arabia said on Monday that the wreckage of missiles fired by Houthi rebels in Yemen bore features of weapons made near Tehran, Iran. Saudi Arabia also declared the 2015 nuclear deal between Iran and global powers a “flawed agreement.”
Favorable Demand-Supply
The International Energy Agency (IEA) recently revised its global oil demand outlook upwardly to 99.3mb/d in 2018. Venezuela, which has the world's largest proven oil reserves, has been registering a decline in crude production in recent years. IEA warned that Venezuela’s situation is worse enough to send the oil market into deficit.
Seasonal Tailwind
Investors should note that the energy sector enjoys seasonality at this time of the year. As per equityclock.com, the sector has offered the best monthly average return (over the last 20 years) of 3.2% in April followed by 2.7% in March, 1.3% in February and 1.2% in December. This definitely calls for energy investing in the near term.
Will OPEC Deal Continue in 2019?
Saudi Arabia’s Energy Minister recently commented that the OPEC output cut deal may go into next year. Global oil inventory came down from their inflated level two years ago but maybe needed more cuts to rebalance the oil market successfully especially the shale oil boom in the United States.
ETF Picks
Below we highlight two ETFs that have a P/E ratio less than biggest energy ETF XLE (P/E of 27.65x).
The fund measures the overall performance of companies involved in crude oil refining. Reliance Industries (7.94%), Valero Energy (7.4%) and Phillips 66 (7.3%) are the top three holdings (read: Top Sector ETFs of 2017).
First Trust Energy AlphaDEX ETF (FXN - Free Report) – P/E 13.89x
The underlying StrataQuant Energy Index comprises stocks from the Russell 1000 Index that may generate a positive alpha relative to traditional passive style indices through the use of the AlphaDEX screening methodology. Diamondback Energy (4.17%), Valero Energy (4.06%) and Whiting Petroleum (4.06%) are the top three holdings.
Stock Picks
Investors can pick oil exploration and production stocks with a forward P/E ratio of less than the industry P/E (21.2x). The stocks hail from a top-ranked Zacks industry (top 36%).
Bonanza Creek Energy Inc. – 8.46x
The company is into the acquisition, exploration and development of onshore oil and natural gas properties in the United States. It has a Zacks Rank #1 (Strong Buy).
Antero Resources Corporation (AR - Free Report) – 15.5x
It is an independent oil and natural gas company and hails from a top-ranked Zacks industry (top 42%). It has a Zacks Rank #2 (Buy).
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6 Reasons to Buy These Energy ETFs and Stocks Now
The hated energy sector is now back in favor with $65 crude (up about 9%) and bullish analyst comments. A host of analysts started betting big on this unloved sector. Credit Suisse analysts view the space as attractive for the first time in two years and have raised their rating to market weight from underweight.
Morgan Stanley too is placing bullish bets on energy and has an overweight rating on it. The space, measured by Energy Select Sector SPDR ETF (XLE - Free Report) (down 2.7%), outperformed the broader market denoted by SPDR S&P 500 ETF (SPY - Free Report) (down more than 4.9%) in the last one month (as of Mar 28, 2018) (read: Energy ETFs Rally: Will the Gains Last?).
Analysts believe that the winning trend in the energy space will be maintained ahead. Below we highlight the reasons behind this bullishness.
Solid Earnings Growth
Energy sector earnings are expected to be up 60.8% in the first quarter of 2018 from the year-ago period after 157.2% year-over-year earnings growth in the preceding quarter, per the Earnings Trends issued on Mar 23, 2018. Revenue growth will likely be 15.7% in Q1 after a 23.8% increase in top line in Q4.
Compelling Valuation
Credit Suisse analysts believe that extended valuations led energy stocks to underperform since mid-2016, despite a favorable operating backdrop and strong earnings. But a host of tailwinds and “weaker stock prices makes the sector's valuations more attractive than they have been in several years."
The Shiller P/E for energy sector is 18.60x, the lowest among the S&P 500 universe. The broader market index has a Shiller P/E of 31x.
Geopolitical Concerns
Geopolitical risks in the Middle East, especially the strained relationship between Saudi and Iran, can act as a key driver. The Arab coalition led by Saudi Arabia said on Monday that the wreckage of missiles fired by Houthi rebels in Yemen bore features of weapons made near Tehran, Iran. Saudi Arabia also declared the 2015 nuclear deal between Iran and global powers a “flawed agreement.”
Favorable Demand-Supply
The International Energy Agency (IEA) recently revised its global oil demand outlook upwardly to 99.3mb/d in 2018. Venezuela, which has the world's largest proven oil reserves, has been registering a decline in crude production in recent years. IEA warned that Venezuela’s situation is worse enough to send the oil market into deficit.
Seasonal Tailwind
Investors should note that the energy sector enjoys seasonality at this time of the year. As per equityclock.com, the sector has offered the best monthly average return (over the last 20 years) of 3.2% in April followed by 2.7% in March, 1.3% in February and 1.2% in December. This definitely calls for energy investing in the near term.
Will OPEC Deal Continue in 2019?
Saudi Arabia’s Energy Minister recently commented that the OPEC output cut deal may go into next year. Global oil inventory came down from their inflated level two years ago but maybe needed more cuts to rebalance the oil market successfully especially the shale oil boom in the United States.
ETF Picks
Below we highlight two ETFs that have a P/E ratio less than biggest energy ETF XLE (P/E of 27.65x).
VanEck Vectors Oil Refiners ETF (CRAK - Free Report) – P/E 11.34x
The fund measures the overall performance of companies involved in crude oil refining. Reliance Industries (7.94%), Valero Energy (7.4%) and Phillips 66 (7.3%) are the top three holdings (read: Top Sector ETFs of 2017).
First Trust Energy AlphaDEX ETF (FXN - Free Report) – P/E 13.89x
The underlying StrataQuant Energy Index comprises stocks from the Russell 1000 Index that may generate a positive alpha relative to traditional passive style indices through the use of the AlphaDEX screening methodology. Diamondback Energy (4.17%), Valero Energy (4.06%) and Whiting Petroleum (4.06%) are the top three holdings.
Stock Picks
Investors can pick oil exploration and production stocks with a forward P/E ratio of less than the industry P/E (21.2x). The stocks hail from a top-ranked Zacks industry (top 36%).
Bonanza Creek Energy Inc. – 8.46x
The company is into the acquisition, exploration and development of onshore oil and natural gas properties in the United States. It has a Zacks Rank #1 (Strong Buy).
Antero Resources Corporation (AR - Free Report) – 15.5x
It is an independent oil and natural gas company and hails from a top-ranked Zacks industry (top 42%). It has a Zacks Rank #2 (Buy).
Want key ETF info delivered straight to your inbox?
Zacks' free Fund Newsletter will brief you on top news and analysis, as well as top-performing ETFs, each week. Get it free >>