Oil stocks have never been so cheap, but there are no signs yet that prices have bottomed out. We’re still waiting for a turn in market sentiment, say head of Automated Intelligence Equity Tjeerd van Cappelle at NN Investment Partners and NN Energy fund manager Anastasia Naymushina (photo).
The NN Energy fund invests globally in companies in the energy sector and is down almost 50% year-to-date. Over the past six years, the negative return measured in US dollars averaged 6.9% per annum, compared to -5.2% for the MSCI World Energy Index.
As a result of the poor recent performance, the sector is now trading at an extremely cheap valuation. ‘Shares of oil and gas companies have never been so cheap based on the price-to-book value,’ says Naymushina. ‘The price/book value is 0.85, compared to an average of 1.6 over the past ten years. The dividend yield of 7.7% is also above average.’
In her opinion, however, that does not mean that the sector is now a buy. ‘Over the past 40 years, the share price book value has been a good indicator of future returns, but this has by no means been the case in recent years. On the contrary, shares that were trading well above book value have done very well on the stock market,’ notes Naymushina.
Moreover, the price/earnings ratio of 18.8 on the basis of expected profits over the next twelve months is not so low at all, says her colleague Van Cappelle.
Social media
The team not only looks at valuations, balance sheet ratios and other fundamental criteria, but also includes ESG factors and sentiment signals in its systematic investment process. ‘We analyse sentiment on the basis of big data from news sites and social media,’ says Van Cappelle. ‘In general, we use natural language processing to determine whether companies appear in the news positively or negatively, and how often that happens. For example, articles about BP often tell us a lot about the general mood in the sector. In practice, we distil data from hundreds of news reports. For us, this is the most important indicator in the selection process.’
The team expects the energy sector to outperform as soon as the current negative sentiment turns. ‘Share prices only rise when investors become more positive. At the moment we don’t see that happen yet, which is why the energy sector is underweight in our global equity funds,’ says Van Cappelle.
On fundamental grounds he also sees reasons to be cautious. ‘Oil and gas producers can only survive if they change their business models. They have to invest in sustainable energy and reduce their reliance on fossil fuels. This transition brings with it many uncertainties for investors. After all, it is not yet clear who the winners and losers will be,’ says Van Cappelle.
One loser is already certain: producers who extract their oil from oil sands. ‘This is very polluting and therefore not a sustainable business model. We exclude companies that are active in this area anyway on the basis of ESG-criteria,’ according to Van Cappelle.
Vaccine
Last week, investors reacted enthusiastically to Pfizer’s vaccine news. The oil price also went up considerably. But Van Cappelle, remains cautious. ‘Next year corona will not be gone yet and the pandemic will weigh on the growth of the world economy. It will take a few years for oil demand to fully recover.’
In addition to the coronavirus crisis, governments’ climate plans add to the challenges facing the sector. President-elect Joe Biden, for example, wants to end the use of natural gas in power stations over the next 15 years. ‘That obviously has a negative effect on demand, but on the other hand emerging countries are moving from coal to gas-fired power stations. Worldwide, the demand for natural gas will therefore still increase over the next few years,’ says Van Cappelle.
Whether this also applies to oil demand, remains to be seen. ‘It is difficult to say when oil and gas demand will peak,’ says Van Cappelle. ‘However, the sector has traditionally been going through deep troughs and high peaks and in this decade there will undoubtedly be years with a shortage of supply’.
‘There are factors that support the price of oil, but there are many different scenarios imaginable in the coming years,’ he concludes. ‘In our investment process, the lights only turn green once sentiment, and therefore price momentum, improves’.