The energy giants BP and Shell have been among the UK’s winners from this year’s rotation into defensive and dividend-paying stocks, according to data from FE Analytics.
Sels (pictured), says that improvements to management in the sector mean that a sustained recovery is underway globally. “We expect the energy sector to outperform going forward, thanks to improving earnings revisions, better capital discipline and hence improving free cash flow trends,” he said.
“The energy sector is trading on a price-to-book ratio below 1.5 times, which represents a valuation discount of more than 20 per cent to the wider global market,” he added.
“Also, the sector has been unloved for some time, with global investors substantially underinvested.”
Data from FE Analytics shows the FTSE World Oil & Gas sector has substantially underperformed the broader market over the past three years, having been left behind in the sharp rally of last year.
Performance of sector vs index over 3yrs
Source: FE Analytics
“Low valuation and disappointing performance have persisted for some time now, mainly driven by negative earnings trends,” Sels said.
“However, the pace of downward revisions has slowed relative to the wider market, and expectations now appear reasonable.”
“Furthermore, improving earnings surprises may finally become a catalyst for a re-rating.”
The analyst is particularly encouraged by the progress made by management of the major oil and gas companies in recent years.
“Following many years of high investment spending the energy sector now seems to be focussing on capex discipline and cash generation,” he said.
“The high levels of cash flow available in the sector should, in our view, trigger share buy-backs and cause dividend payments to rise across the sector, supporting total returns for shareholders.”
Sels’ optimism is backed up by research from BP suggesting that the oil price is at its most stable since the early 1970s.
The company’s annual statistical review showed that the reductions in global supply caused by troubles in the middle east and north Africa are being exactly offset by the new production coming online from the shale reserves in North America. The result is an unusual stability to global oil prices.
Investors who want to take advantage of a rebound in the sector have a number of options.
The $285m Guinness Global Energy fund has 94.4 per cent in the oil and gas sector and has done extremely well out of this allocation in recent months.
It is one of the top-performing funds in the IMA Global sector over the past year, having made 26.31 per cent.
Performance of fund vs indices over 1yr
Source: FE Analytics
Much of the fund is invested in companies involved in shale oil and gas production, including Newfield, Valero and Noble, the three largest stock positions.
Managed by Tim Guinness, Will Riley and Jonathan Waghorn, the fund is Ireland-domiciled and has ongoing charges of 2 per cent.
Investec Global Energy and Jupiter Global Energy are the top-performing of the remaining specialist options: the Investec fund is up 17.8 per cent over a year and the Jupiter fund 14.81 per cent.
Performance of funds over 1yr
Source: FE Analytics
Both funds have top 10 positions in the world’s oil and gas majors such as BP, Exxon Mobil and Total.
The Jupiter fund, which at £23m is much smaller than the £155m Investec portfolio, has 26.21 per cent in UK-listed companies, about 50 per cent more than its peer. Both have around 60 per cent in the US.
Alternatively, investors could look to one of the natural resources funds, which invest in basic materials as well as fuels.
The Martin Currie GF Global Resources fund has 44.2 per cent in oil and gas and the Investec Global Natural Resources fund 44 per cent.
Investec Enhanced Natural Resources has 41.6 per cent and CF Canlife Global Resource 32.7 per cent.
The top-performing portfolio is the CF Canlife fund, although this is the harder to gain access to. The £13m minnow is up 35.19 per cent over the past 12 months, boosted by holdings in miners such as Rio Tinto, First Quantum Minerals and Anglogold Ashanti amongst others.
Martin Currie Global Resources, the most-exposed to fossil fuels, has also done well, returning 26 per cent over the period. Total, BHP Billiton, Exxon Mobil and Shell are the top four holdings.
Performance of funds vs indices over 1yr
Source: FE Analytics
A final option is to buy a UK equity fund with a high weighting to the sector. FE data shows that Royal London UK Growth has as much as 21.6 per cent in oil and gas and Royal London UK Ethical Equity has 20.3 per cent.
Bradley Mitchell runs both portfolios, and Shell is the top holding on the two funds while BG Group also appears in the top 10.
The UK equity team at Majedie are also big believers in the turnaround story: Majedie UK Equity has 18.16 per cent in the sector and Majedie UK Focus 18.75 per cent.
The two UK-listed oil majors are the largest holdings on both funds, making up over 15 per cent on their own.
Henderson UK & Irish Smaller Companies offers smaller company access to the sector in contrast to the majority of funds listed.
It has 19.2 per cent in the sector including top 10 positions Eland Oil and Gas and Ascent Resources. Both have been volatile stocks in recent months.
HSBC’s Sels does warn that there are threats to the success he expects for the oil and gas sector.
A sharp fall in global growth could weigh on energy demand, he warns, while environmental issues could impact margins. Regulatory risks remain, he adds.
