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Oil in good time - While not the ‘raging buy’ some suggest, the energy sector is now on our radar

01/03/2016

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

In the wilder days of his youth, before the change of direction that saw him become a philosopher, a bishop and, ultimately, a saint, Augustine of Hippo is said to have uttered the prayer “Give me chastity – but not yet”. Here on The Value Perspective, we nurture similar sentiments towards oil and gas companies. 

On some metrics, the sector looks to be screaming out for value investors’ attention – for example, as the following chart shows, its relative price-to-book ratio stands at its lowest level since 1927. That, incidentally, makes it comparable to the financial sector in 2009 – an opportunity we felt was far too good to pass up at the time. So why is it we are less convinced about oil and gas in 2016?

 

Source: Empirical Research Partners Analysis

One answer lies in how the above eye-catching metric is relative rather than absolute – in other words, it is looking at the oil and gas sector versus the broader market rather than at the industry’s valuation in its own right. And while, as the next chart shows, oil and gas companies by no means look extended in absolute price-to book terms, it would be too much of a stretch to call them generational bargains.

 

Source: Empirical Research Partners Analysis

In the stormy period from 2007 to 2009, the world’s oil and gas companies were generally seen as one of the last bastions against the havoc being wrought elsewhere. Today, of course, they are seen as anything but as investors queue up to ask genuine and serious question about the sector’s solvency, dividend prospects and general outlook. 

Here on The Value Perspective, we are not suggesting there are any easy answers to such questions – very broadly, some dividends look stretched yet most of the large integrated companies’ balance sheets should hold up under the strain – but what we can say for certain is oil and gas is an area we are now spending a large proportion of our time investigating. 

One thing making our work especially difficult, though, is there are no ‘free hits’ in this sector. The cheapest companies are that way for good reasons – they have real troubles and, with the oil price around $30 (£21) a barrel, they are unlikely to survive. Barring an imminent rebound in that price, which could happen but is hardly something you would wish to rely upon, some – perhaps many – businesses will go under. 

We do believe that, thanks to their very large balance sheets and broad exposure – both in terms of geography and the distinct ‘upstream’, ‘midstream’ and ‘downstream’ elements of the industry – the integrated oils should survive and certainly warrant further attention. They are just not the ‘raging buys’ either their relative price-to-book metrics would suggest or that financials were back in 2009.

 

Author

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

Important Information:

The views and opinions displayed are those of Ian Kelly, Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans and Simon Adler, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated. They do not necessarily represent views expressed or reflected in other Schroders' communications, strategies or funds. The Team has expressed its own views and opinions on this website and these may change.

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