Should You Explore Energy Stocks?

Crude prices have taken a beating, but S&P maintains a positive fundamental outlook on the Integrated Oil & Gas group. Exxon Mobil and Chevron are top picks

By Sam Stovall From Standard & Poor's Equity Research

S&P 1500 Integrated Oil & Gas Index vs. the S&P 1500, as of Nov. 14, 2008

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The benchmark West Texas Intermediate (WTI) grade of crude oil now trades below $57 per barrel, more than 60% below its recent peak. What's more, from the Oct. 9, 2007, stock market peak through Nov, 14, 2008, five of the seven subindustries in the S&P 500 Energy sector performed worse than the broader market, logging declines of 43% to 70%, vs. a 42% drop for the S&P 500.

One glaring relative outperformer was the Integrated Oil & Gas group, which fell only 26.4%. This subindustry, which represents 65% of the market capitalization of the S&P Energy sector, is currently trading at a price-earnings ratio of only 6.4 times, based on estimated 2009 EPS, versus 9.4 times for the broader market. In addition, the subindustry is providing a dividend yield of 2.7%, vs. a 3.1% yield for the S&P 500. Are these global behemoths worth a second look?

Take a look at the accompanying chart. As a reminder, the jagged blue line represents the subindustry index's rolling 52-week price performance as compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the index's long-term mean relative strength.

Top Rankings

There are seven large-cap stocks in the S&P 1500 Integrated Oil & Gas subindustry index. Of those, five carry top S&P investment rankings of 4 STARS (buy) or 5 STARS (strong buy). Chevron Corp. (CVX), ConocoPhillips (COP), and ExxonMobil (XOM) each carry a 5 STARS ranking, while Marathon Oil (MRO) and Occidental Petroleum (OXY) weigh in at 4 STARS.

Tina Vital, the analyst who follows this subindustry for S&P, has a positive fundamental outlook for the Integrated Oil & Gas group, reflecting attractive fundamental valuations. She expects the so-called U.S. supermajor oil companies to post 2008 profits up 36% from 2007.

But Vital notes that with the effects of the credit crisis spreading internationally, impacts across the energy sector are intensifying. Budgets are being cut, and it is increasingly difficult to expand oil and gas production.

Standard & Poor's is pessimistic about current and future supply trends, which are expected to put upward pressure on oil prices when demand rebounds but supplies remain flat. In the meantime, the current slippage in supply is probably not enough to offset reduced global demand—focusing attention on OPEC, which agreed to cut its output at an emergency meeting on Oct. 24. Vital expects a series of supply cuts amid falling demand for crude.

Global Outlook

Standard & Poor's expects world economic growth in 2009 to be the slowest since 2003. U.S. growth is likely to slow before rising, the outlook for Europe has darkened, and growth in Asia is slowing, albeit from high levels. Still, oil demand weakness within the OECD regions is being offset by strength in Asia and the Middle East. As of November 2008, the independent economic forecaster Global Insight estimated that global oil demand growth will average 0.29 million barrels per day in 2008 and 0.19 million b/d in 2009, compared with 1.07 million b/d in 2007; global oil supply growth was estimated at 1.38 million b/d in 2008 and 0.19 million b/d in 2009, compared with a rise of 0.11 million b/d in 2007.