Credit Suisse analysts say energy stocks have become attractive again for the first time in two years, based on strong earnings growth and improved valuations.
"Extended valuations had resulted in Energy's underperformance since mid-2016, despite a favorable cyclical backdrop, rising oil prices, and robust earnings growth. A combination of strong fundamentals and weaker stock prices makes the sector's valuations more attractive than they have been in several years," the researchers wrote.
Oil prices have been rising on geopolitical concerns and a better supply/demand outlook, following a recent sell off. West Texas Intermediate futures were slightly weaker Monday, but they came within 14 cents of a more than four-year high early in the session. WTI futures for May hit a high of $66.55 per barrel, a level it also reached in January.
Credit Suisse raised the energy sector from underweight to market weight, noting they now find the "case against Energy less compelling." Earnings are expected to increase 70 percent this year, after rising more than 120 percent last year.
The S&P energy sector was up 0.7 percent Monday, and is down nearly 7 percent year-to-date. The S&P is down 1.7 percent in the same period. The Energy Select Sector SPDR Fund XLE was also up 0.7 percent Monday.
"Energy and each of its major sub-groups have delivered superior earnings growth since mid-2016 on rising oil prices and a robust economic backdrop. That said we have been underweight the group given extremely stretched valuations and the belief that technological advancements will keep crude prices in check over the long-term," they wrote. They said exploration and production companies have the best growth within the sub-sectors.
Energy's price to earnings ratio is the second highest of major S&P sectors at 19.1 times forward earnings, compared to 16.3 for the overall S&P 500. Discretionary has the highest P/E on future earnings, at 19.7. Technology is at 18 times. Credit Suisse has overweighted
discretionary, tech and financials.
Source: Credit Suisse
Morgan Stanley analysts, meanwhile, say they have become even more positive on the sector.
"Better inventory data, seasonal and cyclical supply/demand imbalance, and rising geopolitical risk make us increasingly positive on overweight Energy," they wrote.