Ever since the price of crude oil began rebounding from its recession low of about $34 (U.S.) a barrel in mid December, the stocks of oil producers have also bounced higher - but nowhere near the level of the underlying commodity. Oil has doubled in price while Canadian energy stocks are up just 31 per cent and U.S. energy stocks have lagged even further.
For Savita Subramanian, quantitative strategist at Bank of America Merrill Lynch, one of the reasons for this lag is that oil stocks have relatively low earnings expectations built into their prices. She figures analysts are using $49-a-barrel oil for their estimates, on average
"Our model suggests it is not a coincidence that this is roughly where oil was trading three months ago, as oil prices tend to lead estimates," she said in a note. "Therefore, unless [crude oil]reverts back to $50 a barrel (from $68 currently), we expect to see positive revisions for the Energy sector over the next few months."
Based on current earnings estimates, she believes the U.S. energy sector is overvalued. But if earnings estimates are revised to reflect a higher oil price, then there is a 17 per cent upside to energy stocks.
"At the end of last September, we noted that Energy was a value trap rather than a real opportunity," Ms. Subramanian said. "At that point, the sector still appeared inexpensive, but largely because consensus reflected $105 a barrel [crude oil]or had not caught up with substantial oil price declines. Since September, earnings expectations have fallen by almost 60 per cent. Today, we suspect we are seeing the opposite scenario - estimates seem to be too low and valuation is more compelling than it appears."