BMO Nesbitt Burns's view of energy stocks took a dramatic turn this week. Chief investment strategist Brian Belski changed his outlook on the sector to neutral after months of exasperation with investors he felt had been far too bullish and "obsessed" with finding a market bottom.
A closer look at analyst profit forecasts in energy stocks highlights a broad improvement in sector optimism and a potential inflection point for investors.
The accompanying top chart, showing changes in analyst 12-month earnings forecasts for each TSX sector for the past three months, constitutes the bad news. The analyst community took an axe to energy and materials profit expectations, taking them lower by 20.3 and 23.6 per cent respectively.
The S&P/TSX utilities index profit estimates were also notable as the usually consistent sector saw their earnings forecast cut by 4 per cent. The only sector showing a notable improvement in outlook was health care, a sector driven almost entirely by Valeant Pharmaceuticals International Inc.
The second chart, showing more recent developments in profit forecasts, is much more positive. Analysts remain bearish on materials stocks, but the upgrade in earnings expectations for the energy sector – an increase of 6.6 per cent – represents an abrupt and welcome change in sentiment.
Even with the improvement in estimates over the past month, profit forecasts in the energy sector are not what they were three or six months ago. Mr. Belski himself warned that in most cases, Canadian oil stocks are still too expensive and thinks the U.S. energy sector offers better value. But the change in direction for domestic profit growth projections in this sector is important and may – and I emphasize "may" – signal that the worst is behind for domestic energy stocks.
To identify the individual stocks driving sector optimism, I ranked all members of the S&P/TSX energy index by four-week change in earnings expectations and listed the top 12 in the accompanying table.
The biggest percentage improvement in forward 12-month earnings expectations are from highly speculative stocks where, in many cases, mere pennies a share in profits were expected. Advantage Oil & Gas for instance, saw a 15.8-per-cent increase in profit forecasts in the past four weeks, but this amounts to only a couple of pennies in improvement. In other cases, like Enerplus Corp., Pacific Exploration & Production and MEG Energy Corp., the company is still expected to operate at a loss despite the profit upgrade.
Volatile commodity markets imply considerable risk in all of these stocks. Fundamental research, as always, must be undertaken before adding any of these positions to investment portfolios.
Follow Scott Barlow on Twitter @SBarlow_ROB.