What are we looking for?
Global energy stocks that look both relatively inexpensive and relatively low risk.
Time to get energized
Global markets have been slow to warm up to the energy story this year, despite strong oil prices. Even with a relatively strong performance in the past month, the year-to-date returns on the MSCI World Energy index are still mildly negative, and lag the overall MSCI World Index by about four percentage points.
But strategists Pierre Lapointe and Alex Bellefleur of Brockhouse Cooper in Montreal believe a change in sentiment toward the sector is at hand. In a recent report, they pointed to a recent surge in speculative long positions held in crude oil futures CL-FT– which hit record levels last month – as evidence that the market is increasingly convinced that higher oil prices are here to stay. They also noted that even as oil prices have picked up, implied volatility in the oil futures market remains historically low.
Taken together, the two indicators suggest that the investment community is warming up to the energy group, while remaining comfortable with the risk levels built into energy prices. It implies that there could be healthy upside to come for energy stocks.
The screen
Given that view, the strategists wanted to identify the big global energy names that have both underperformed the overall MSCI World index this year and have relatively safe risk profiles. They wanted to weed out stocks that have high-risk exposure – the kind of stocks that are perhaps carrying a low price for good reason.
To do so, they started by looking at all the S&P Global 1200 energy stocks whose total returns for the year to date have lagged the overall MSCI World index. Then it screened out any company whose five-year credit default swap spread is greater than 200 basis points, “to avoid companies with undue levels of event risk.”
The screen – updated by Mr. Bellefleur for this column – produced eight stocks from four countries, including three Canadian names (Encana Corp., Nexen Inc. and Talisman Energy Inc.). Interestingly, Nexen and Encana not only have the two worst year-to-date total returns, but they also rank in the bottom half of the list in trailing price-to-earnings ratio. The underperformance, low valuation multiple and relatively low-risk profile for both stocks suggest they could do very well in an energy-sector rally.
