Large cap Energy is still our favorite sector even though it made a new 52-week high yesterday (ETF symbol XLE), so let’s talk about why we think this group still has room to work.
To keep things simple, let’s look at ExxonMobil and Chevron. These two names comprise 44 percent of the S&P large Cap Energy sector with the former at 23 pct of the index and the latter at 21 pct.
Starting with each company’s current valuation based on 2022 expected earnings per share:
- ExxonMobil trades for 9.0x expected 2022 earnings of $10.13/share.
- Chevron trades for 11.1x expected 2022 earnings of $15.52/share.
- The S&P 500 trades for 17.5x expected 2022 earnings of $229.22/share, so Energy stocks are still very cheap relative to the market.
Now, last night we outlined how Wall Street analysts have been cutting their 2022 estimates over the last few weeks for the companies of the S&P 500; is the same true for XOM and CVX? Not even close:
- Over the last month Energy sector analysts have increased their Q2 2022 estimates for XOM by 27 percent (not a typo), from $2.26/share to $2.87/share. They have also increased their 2022 whole-year estimate by 16 percent over the same timeframe, from $8.72/share to $10.13/share.
- For CVX, analysts have raised their Q2 estimates by 23 percent over the last 30 days, from $3.66/share to $4.49/share. Their whole-year estimate now is $15.52/share, as mentioned, up 15 pct from a month ago.
So, in Energy we have a cheap group where earnings estimates are going up a lot, but how soon before this earnings power is fully baked into stock prices? One way to think about that is to look at analysts’ 2023 earnings estimates. If those anticipate even more earnings growth, then perhaps expectations have gotten ahead of themselves. This is not the case, however:
- Analysts expect ExxonMobil’s earnings to decline 13 percent in 2023, to $8.78/share from $10.13/share this year.
- They also expect to see Chevron’s earnings drop next year, to $13.96/share from $15.52/share in 2022, a 10 percent reduction.
How likely is it that ExxonMobil and Chevron will earn less in 2023 than in 2022? Hard to know, of course, given uncertainties around oil prices and global economic growth. Even still, with the stocks trading at 10 – 12x 2023 estimates you’re not paying much in terms of valuation to find out the answer.
Takeaway: having covered a cyclical group (autos) for all the 1990s, I (Nick) can tell you only one thing drives these sorts of names – sustainably higher earnings than the market expects. You might think that applies to all stocks, and that’s true to a point, but it is especially true for grimy cyclicals like car companies and oil/gas businesses. They don’t have a secular growth story like Tech, so investors only pay attention to these names when they are dramatically outperforming on the bottom line and estimates are going up. That is happening now and given how low 2023 estimates are we expect that will continue.
As for where Energy can go from here, we’ll leave you with this thought: why can’t the sector be worth as much as Apple in the S&P 500? Apple has a 6.7 percent weight in the index. Energy is 4.6 percent. Does that make sense in the current environment? We tend to think not, and we love our Apple products. But we need gasoline to get around.