Global Relative Value: Oil - integrated and E&P
Relative Value Global: Oil – integrated & E&P
LONG (on a relative basis) XLE US: $78.90; IXC US: $37.7; XOP US: 49.00; OIL FP: Eur33.00; PBR US: $9.00; LKOD LI: $46.48; Brent M05: $75.3 December 1, 2014 Following OPEC’s decision not to cut output after the recent fall in oil prices, in particular due to a glut of crude brought about by overproduction in the US (aka the fracking revolution), oil prices collapsed further last Friday, causing a crash in oil/energy related shares on Friday, and this morning in Europe. E&P companies are the most affected, being the high beta stocks in the sector as they are directly linked to changes in the price of crude. One immediate consequence of the oil bear market was the abandonment of the Petroceltic deal by Dragon Oil, with Petro Celtic dropping by almost 40%. Following our positive report on oil drilling and services, we are positive on oil/energy stocks in general, and particularly on E&P companies which are reaching ridiculous levels of valuations, exceeding (on the downside) the lows of 2008/09 when crude collapsed to $40.
1. OIL in the global valuation context As highlighted in our global strategy report (Oct 8), out of the top 50 best value stocks, 18 are energy stocks highlighting the undervaluation of the sector. In the US, of the top 25 best value stocks, 13 are energy, including 10 oil stocks (4 integrated; 6 E&P) and 3 oil services stocks. In Europe, out of 14 top undervalued stocks, 4 are energy. The story is the same in emerging markets where Russian oil stocks, Petrobras, and CNOOC (China) feature prominently amongst the best value opportunities. Even in Japan, Inpex is ranked #1 in terms of value vs. margins In fact on a global basis, of the top 10 best value vs. margins stocks, 9 are oil stocks (Inpex, 6 Russians, Statoil, Sasol). In terms of relative performance, the oil sector, be it on a global basis, or market by market is not only significantly oversold, but is selling on relative lows that are overshooting the preceding lows of 2008-09 when oil collapsed to $40. This would suggest that either the oil price is on for another significant leg down, or that on the contrary, if oil prices were to stabilize, the energy sector is due for a significant rally. E&P E&P are the high beta stocks in the energy sector. The following two charts are showing the relative performance of US E&P stocks to the US Energy sector and to the Oil Services sector. As can be seen, E&P are massively underperforming in the current oil rout. In fact as the chart below shows, the relative underperformance of the E&P sector vs. Energy is similar to the 2008 relative collapse. However, again the 2008 move took place in an environment where oil collapsed from over 140 to $40 CONCLUSIONS & TRADE RECOMMENDATIONS As demonstrated above, oil stocks are undervalued relative to world equity markets, and particularly so in the US and Europe. Relative performance of energy stocks to indices would tend to indicate that either oil stocks are extremely oversold (relative), or oil prices should plunge further. As such, we would overweight energy stocks in any long equity portfolio. This sector allocation bet was also highlighted in our last strategy report where we highlighted through a bottom-up stock selection based on relative values and profitability trends and cycles that the energy sector was the most attractive in all markets. CORE LONG OIL STOCKS ENI (ENI IM): Eur 16.7 STATOIL (STL NO): NOK 126 ENCANA (ECA CN): C$ 17.80 PETROBRAS ON (PBR US): $9.12 (we recommend Petrobras in US$) Russian Oil or Market Vector Russia (RSX): $19.60 (Gazprom, Novatek, Lukoil, Bashneft) KMG EP (KMG LI): $ 15.25 DRAGON OIL (DGO LN): GBP 5.02 OIL & NATURAL GAS (ONGC IN): INR 364.4 OIL INDIA (OINL IN): INR 571 INPEX (1605 JP): JPY 1219 BEACH ENERGY (BPT AU): A$ 0.98
SPECIAL SITUATIONS: BAKER HUGHES (BHI US): US$ 56.5 long the US sector with a 15% cushion/kicker PETROCELTIC (PCI LN): GBP 1.14 collapsed deal more than 100% higher; co. is for sale. PETROBRAS ARGENTINA (PZE US): $ 6.0 potential minority buyout; at a fraction to YPF TALISMAN ENERGY (TLM CN): C$ 5.14 ultra-cheap Canadian E&P co. Icahn main shareholder. PACIFIC RUBIALES (PRE CN): C$ 10.18 stake building by Alfa Group above C$20. High probability of a take-out BASHNEFT (BANE RM): RUB 1219 (US$ 23.6) majority stake expropriated by Russian gvt from Sistema. Significantly undervalued; stake could be resold later at a much higher price.
LONG / SHORT MEAN REVERTING / RELATIVE VALUE TRADES: The following tables are showing the MRI for the various possible pair trades in the global energy sector. Highly mean reverting trades are highlighted in yellow. Of these we recommend the following trades based on relative values and price dislocation: Long E US (ENI ADR), Statoil (STL NO) / Short IXC US Long Oil futures (CLH5) /Sshort CNOOC (883 HK) Long Lukoil (LKOD LI), Novatek (NVTK LI) / Short XLE US Long XOP US, (OXY US, APC US) / Short RDSA LN Long Petrobras (PBR), OIH US, RSX US / Short CNOOC (883 HK) Long Lukoil (LKOD LI) / Short Sinopec (386 HK) Long Gazprom (OGZD LI) / Short RSX US Long RSX UX, Lukoil (LKOD LI), Gazprom (OGZD LI) / Short Schlumberger (SLB) We note that the Russian stock market (RTSI$ or ETF RSX) is most mean reverting with crude oil prices and a large number of oil stocks. Russian oil stocks have been among the best performing energy stocks in the last 3 months.