Energy investors are “underestimating the underinvestment in the sector over the past five years,” says one analyst.
Luke MacGregor/Bloomberg
Energy stocks are on sale, after a sharp selloff since oil and natural-gas prices peaked in early June.
Oil is down 18% from its high, to $102 a barrel, while gas has fallen by a third, to about $6 per million British thermal units.
The Energy Select Sector SPDR exchange-traded fund (ticker: XLE), dominated by Exxon Mobil (XOM) and Chevron (CVX), has dropped 23%, to $71, and the more volatile SPDR S&P Oil & Gas Exploration & Production ETF (XOP) is off 30%, to $119.
“Investors are concerned about what will happen to energy demand if we go into a deep recession,” says Mark Stoeckle, manager of the Adams Natural Resources closed-end fund (PEO). “But they’re underestimating the underinvestment in the sector over the past five years.”
With supply constrained, he sees oil holding above $80 a barrel, even in a worst-case scenario. The Adams fund trades around $19, yields 3%, and changed hands recently at 13% below its net asset value. The industry should be very profitable at current prices.
“The smart money in the room thinks we’re still early” in the cycle, says Bill Smead, co-manager of the Smead Value fund (SVFFX), whose largest holdings are Continental Resources (CLR) and Occidental Petroleum (OXY).
Berkshire Hathaway (BRK.A) CEO Warren Buffett continues to accumulate Occidental shares aggressively and now owns nearly a nearly 19% stake in the energy company, worth about $11 billion. Occidental has held up better than the sector lately, due to Berkshire’s purchases; its stock gained 3% this past week, to $62.
The Berkshire buys have spurred speculation that Buffett may have finally found his long-sought “elephant” and buy the remaining 81% of Occidental. At a possible price of $75 to $80 a share, that would cost about $60 billion. At $75, Occidental would be valued at just 7.5 times projected 2022 earnings. Berkshire, which didn’t respond for a request for comment, is sitting on more than $100 billion in cash.
Buffett knows Occidental well, having purchased $10 billion of attractively priced 8% preferred stock in 2019 when the company needed money quickly to outbid Chevron for Anadarko Petroleum. He loves American companies, and Oxy gets about 80% of its energy production of over one million barrels a day from the U.S.
Buffett potentially could combine all or parts of Occidental with his Berkshire Hathaway Energy unit, which owns U.S. electric utilities and natural-gas pipelines. Increasingly valuable BHE, one of the nation’s largest renewable-power generators, could be worth $75 billion. Berkshire itself is now valued at $615 billion.
Gas stocks have been particularly hard hit recently. Industry leader EQT (EQT) the country’s largest producer, is down more than 30% from its June high, to $34. However, gas demand is more recession-resistant than oil because of its use for electric power and heating. And then there’s the long-term bull case, keyed off growing worldwide demand for liquefied natural gas.
There is no bigger gas booster than EQT’s CEO, Toby Rice, who advocates for a quadrupling in U.S. LNG capacity by 2030. If that happened, U.S. natural gas could easily replace Europe’s current imports from Russia. He calls the coal-to-gas conversion in overseas power generation “the largest green initiative on the planet.” Gas produces about half the carbon emissions of coal.
EQT shares look attractive; its way-below-market hedges will roll off in 2023, resulting in sharply higher free cash flow. “It’s a really exciting story,” Rice tells Barron’s. “I need to do a better job of explaining it, because right now EQT trades [at] over a 25% free-cash-flow yield. It’s an incredible investment opportunity.” He’s referring to projected 2023 free cash flow.
After a 20% pullback from a record high in late March, Berkshire stock also looks appealing, changing hands around 1.3 times book value—below its average 1.4 times valuation over the past five years. And book value significantly understates what Buffett calls Berkshire’s intrinsic value. Late last week, its class A stock was trading at $422,000; the class B, at $281.
Buffett’s investments this year, plus the benefit of higher short-term rates on Berkshire’s huge cash holdings, could lift its annual profits by nearly $5 billion, off a projected base this year around $29 billion in after-tax earnings. A full Occidental purchase could boost earnings by $10 billion, assuming that oil and gas prices don’t radically fall.
Freeport-McMoRan (FCX) and Rio Tinto (RIO) mine copper and iron ore. But their stocks could turn out to be golden.
These cheaply valued shares discount a deep recession but don’t reflect the huge improvement in their industry’s balance sheets since the last commodity downturn in 2016.
At $29, shares of top global copper miner Freeport-McMoRan are 44% below their March peak, as copper has slid 25%, to about $3.60 a pound. Freeport now trades for seven times 2022’s projected earnings and nine times 2023’s—with next year’s estimate reflecting expected lower copper prices. The stock yields 2%—including its base and variable dividends.
Freeport and Rio Tinto are top picks of Jefferies analyst Chris LaFemina. “The market, in the past month, has gone from pricing in a stagflation where commodities would be strong to a deflationary downturn,” he says.
LaFemina is more upbeat on commodity demand, noting that the economic situation in China—the dominant consumer of industrial commodities—has improved in the past month. “There still is earnings cyclicality, but the catastrophic risk for these companies, from a balance-sheet perspective, has been resolved,” he says.
Freeport, for instance, has cut its net debt to $1 billion from $20 billion since 2016. “Freeport is leveraged to a longer-term recovery in the global economy,” he observes. The multiyear copper outlook looks strong, owing to the growth of copper-intensive electric vehicles and renewable power. That’s why some call copper the greenest metal.
Shares of Rio Tinto, a copper miner that also is one of the leading global iron-ore producers, are down to $59 from $85 in March. They fetch five times the 2022 earnings estimate and seven times next year’s. And the company has net cash on its balance sheet. “Rio is trading at a global financial-crisis valuation,” LaFemina says. He sees its dividend yield staying in the high single digits, even if iron-ore prices fall further.
Write to Andrew Bary at [email protected]
