No, It’s Not a Good Time to Buy Oil Stocks

Energy stocks are, by far, the worst performing sector in the S&P 500 so far this year. That doesn’t make them a buy, however. Mizuho’s Carmine Grigoli and Ujjal Basu Roy explain:

Reuters

The massive sell-off in oil stocks has investors wondering if it is a good time to buy. Indeed, some pundits are recommending that investors increase energy holdings. We disagree and maintain our underweight in energy stocks. Simply, we expect a protracted downturn in oil prices, big cuts in earnings forecasts and stock prices are not cheap enough to encourage us to look beyond existing problems and anticipate better times ahead…

Without a sustained turnaround in crude oil prices, energy stocks could remain under pressure, in our view. Our research shows that risk of earnings disappointment is high as analysts' 2015 profit forecasts are factoring in a sizable recovery in WTI crude to roughly $90 a barrel. Based on current 2015 earnings forecast, the energy sector trades at P/E multiple of 14.3 times compared to P/E for the S&P 500 of 15.6, a relative high valuation given the uncertain and historical relationships.

Still, explorers seem relatively optimistic about their plans, Grigoli and Roy note:

According to ConocoPhillips (COP), 80% of U.S. shale oil could be produced profitably at oil prices around $40-80 while the CEO of Occidental Petroleum (OXY) has stated that much of oil production in the U.S. is viable at $753. Some companies such as Anadarko Petroleum (APC) have emphasized that recent developments in the commodity markets were not going to have much impact on its exploration plans. Others such as Pioneer Natural Resources (PXD) have stated that the company could increase production by 16%- 21% through 2016 at oil prices in the range of $70-80 while EOG Resources (EOG) has maintained that it was going to post strong double-digit gains in oil production going forward despite the low price environment. Meanwhile, Chesapeake Energy (CHK) raised its production guidance for this year and noted that despite lower oil prices, declining production costs have enabled it to raise its production this year.

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Smaller producers appear to agree, with Whiting Petroleum (WLL) noting that its production growth would be unchanged at oil prices of around $75 while an average oil price in the low $80s would not affect Energen's (EGN) production plans.

Grigoli and Roy recommend increasing positions in Consumer Discretionary companies, which have outperformed the S&P 500 by an average of 8.3 percentage points during past oil slides. The Consumer Staples sector, meanwhile, has outperformed by 4.2 points. “Energy-related consumption boosts have historically translated into superior performance of consumer stocks,” they say.

Investors don’t seem to mind scooping up energy stocks today, however. ConocoPhillips has gained 0.7% to $71.90 at 3:38 p.m., while Occidental Petroleum has risen 1.1% to $86.86, Anadarko has advanced 0.9% to $89.77, Pioneer Natural Resources has jumped 1.4% to $167.42 and EOG Resources is up 1.6% at $97.84.