Energy Stocks Can’t Keep Up With Analysts’ Earnings Exuberance

  • Shares are cheap on a forward-looking basis compared to market
  • Earnings optimism hinges on OPEC, policy and global demand

Energy stocks posted the biggest gains of any sector in the S&P 500 Index last year -- and yet they still look cheap to Wall Street.

Spurred by an improving outlook for global demand and an agreement to cut oil production from OPEC and non-OPEC producers, analyst optimism for energy earnings jumped the most on record over the New Year. This has made the shares inexpensive on a price-to-earnings basis.

The bull case for earnings hinges on a couple of factors. One, that the Organization of Petroleum Exporting Countries will honor its end of the bargain to cut production by 1.2 million barrels a day, keeping supply in-check. And two, that the Trump administration will be lenient with energy companies after the appointment of former Exxon Mobile Corp. Chief Executive Officer Rex Tillerson as secretary of state.

“There’s still some apprehension about the supply dynamics,”said Alan Gayle, a senior strategist at Atlanta-based RidgeWorth Investments, which oversees about $40 billion. “Underlying demand is going to continue to increase as the outlook for the global economy continues to improve.”

In 2016, the S&P 500 energy sector rose more than 23 percent compared with a 9.5 percent gain for the broader gauge. However, the money that poured into U.S. stocks after the election has since stalled, as investors assess whether the market ran too far.

This skepticism hit the energy sector especially hard. The stocks have been locked in a tight trading range since they fell 4.3 percent following a Dec. 13 peak. This has cheapened the shares faster than any other sector in 2017, as judged by their 12-month forward price-to-earnings ratio, data compiled by Bloomberg show.

Still, this remains a highly volatile market. Over the past year, crude prices have churned even the strongest stomachs, dropping as low as $26 dollars a barrel and then rebounding to near $50 a barrel. This volatility has kept investors skeptical, waiting to see earnings growth before piling back into the shares.

Analysts, however, are not waiting to give the green light. While the price side of the ratio is slumping, earnings expectations are skyrocketing. Among analysts surveyed by Bloomberg, the 12-month forward estimate jumped from $3.76 a share to $17.32 in the new year, a more than 360 percent increase, the most since at least 1990. That compares to an 8.9 percent drop in the earnings estimate for the whole S&P 500.

Most of the optimism comes from oil exploration and production companies -- estimates improved from a loss of $11.43 to $4.78 since the end of December. What could dampen this enthusiasm is the return of U.S. production and a quick up-tick in supply, Gayle said.

“Prices in part reflect anxiety or the unknown around how quickly U.S. production can be turned on after it was turned off,” Gayle said. “If it’s something that will take several quarters here in the U.S., then you could find a nice supply and demand balance that would mean better energy earnings.”

— With assistance by Matt Turner

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