Energy may be the market’s worst-performing sector this year, but traders say these 2 stocks in the space look like solid bets right now.
2020 has been a wild year for the market.
The S&P 500 reached a new all time high in late February only to descend into one of the quickest bear markets in history – falling 34% in just over a month. The index then rebounded sharply, gaining 60% by September 2 when it hit a new all-time high.
But September was a brutal and volatile month, and the S&P 500 ended it down nearly -5%.
While nearly every sector has been climbing higher this year, the market’s worst-performing sector has had a pretty dismal year.
The energy sector has dropped this year, and has underperformed the broader index’s 10 other sectors over a range of time frames including this week, this month, and over the last 12 months.
The energy sector has been up against a number of headwinds this year. It was hit particularly hard early in the coronavirus pandemic when people globally were forced to stay home to help stem the spread of the deadly virus – and with people staying home, demand for gasoline all but dried up. Add to that an oil price war between Russia and Saudi Arabia back in March, and the U.S. and Iran nearly going to war in early January, and 2020 has been one heck of a year for the sector.
Year-to-date, oil prices are down more than -32% and the XLE S&P 500 Energy Sector ETF—which tracks the sectors biggest players—is down nearly -52% for the year.
But two traders argue that things could be about to turn around for the sector.
“Hydrocarbons will be here for quite a while and there’ll be a big transition period,” to clean energy sources such as hydrogen power and battery power, said Boris Schlossberg, managing director of FX strategy at BK Asset Management.
“For that reason alone, I think the energy sector at this point actually presents a pretty decent value, especially because right now from a financial point of view, there’s a sort of a game of chicken going on as far as dividends go,” Schlossberg added.
Schlossberg noted that industry heavy-weights Chevron (NYSE: CVX) and Exxon Mobile (NYSE: XOM) still yield 7% and 10%, respectively, and neither of the two have announced plans to cut their dividends.
“If they do not, that makes them one of the greatest yield plays in the world right now at a time when the 10-year is trading at 65 basis points,” Schlossberg continued. “Now if they do cut their dividends—let’s say they even cut it by half—that still makes it a very attractive yield and at the same time also lowers their cash flow needs and therefore I think is a chance for the stock value to go up.”
Given that, Schlossberg argues that investors with longer-term time horizons may want to consider the energy sector at these levels, especially considering the resilience in energy demand and the possibility of more mergers and acquisitions in the space following the Devon Energy (NYSE: DVN) and WPX Energy (NYSE: WPX) merger announced this week.
“We believe after speaking to various E&Ps and industry executives there could be several more deals to follow given the need for upstream companies to continue to become more operationally efficient and financially resilient as commodity prices remain under pressure and investing scrutiny increases,” wrote Truist analyst Neal Dingmann in a note following the Devon Energy-WPX Energy tie-up, adding that the merger will “start a wave of deals” in the space.
“Further, there are numerous operators we forecast will have difficulty continuing to grow and generate at least cash flow neutrality as current stand-alone entities so we believe they may be forced to change their future structures,” Dingmann said.
Schlossberg added, “If you’re a long-term holder, this is one of those great opportunities where you have a chance to buy a very, very beaten-down sector relatively cheaply for the intermediate term, even though very, very long term, certainly, the prospects for the whole sector are kind of negative.”
Blue Line Capital’s Bill Baruch agrees that the energy sector is looking ripe for a rebound.
“This weakness that we’ve seen here this year I think presents a longer-term value opportunity,” Baruch said, adding that crude oil, which was at $38.37 a barrel at Thursday’s close, has “tremendous value” at the $34 – $35 level.
“If it gets down there, it’s going to continue to pressure the stocks,” Baruch said. “I think there’s great value in the stocks. I think Chevron is really a great one.”
Baruch added that he began buying into energy last week with Chevron as the “centerpiece” to his strategy. Baruch argues that the $70 per share level—the stock closed at $70.42 on Thursday—in Chevron “is a good point of balance for the stock.”
“And, as Boris mentioned, those dividends [are] really great right now,” Baruch said. “Even if they do end up cutting those dividends, you could see a flush. I think that flush would be a buying opportunity. So, I’ve begun to allocate in the space and I think there’s good value there over the long run.”