Old-line energy is the best performing sector so far this year and could continue to win

Published Thu, Jan 20 20226:08 AM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

The stock market has struggled this month, but the old-line energy stocks that drill for oil and gas have made double digit gains and could continue to outperform in 2022, analysts say. The sector is up about 16% for the month of January, compared to a 4.9% decline in the S & P 500. The only other major sector that is positive is the financials, with a 0.4% gain for 2022. "We've been in the middle of this inflation trade and growth devalue trade and at the same time, oil prices have been going up," said Dan Pickering, chief investment officer of Pickering Energy Partners. Oil pushed to a new 7-year high this week, amid geopolitical concerns. There are rising tensions between Russia and Ukraine, and over the weekend, Houthi militants attacked the United Arab Emirates' capital of Abu Dhabi. There was also a pipeline outage between Turkey and Iraq. U.S. West Texas Intermediate (WTI) crude futures on Wednesday settled up $1.53, or 1.8%, at $86.96 per barrel, adding to Tuesday's 1.9% gain. Energy stocks took a breather Wednesday in a down market, even as oil rose. The Energy Select Sector SPDR Fund was off 0.7% and was off 0.3% for the week. It is up 15.9% this month so far. "We continue to think the energy complex is undervalued, if you look at their prices relative to crude oil and gas," said Quinn Kiley, Tortoise senior portfolio manager. "The producers are much healthier than they had been. The whole group is a free cash flow yield story." Even before the pandemic began, the oil and gas sector was under siege. The industry had overspent, and shareholders demanded discipline. The stocks also took a beating as investors favored plays that focused on environmental, social and governance or ESG values. Kiley pointed to the SPDR S & P Oil and Gas Exploration and Production Sector ETF. It is up about 13% year-to-date but still about 40% below 2018 highs. "Whether it's by paying down debt to increase equity value or buying back stock, increasing dividends or the special dividends that have popped up in the last year...we think the cash return to shareholders through various functions will continue to grow," Kiley said. Kiley said the group is even more attractive with higher oil prices. "They are not being valued with the cash flow they get from oil prices. Energy has had a run but the run is not done," he said. "You're talking about companies that have 20% plus free cash flow." For instance, Pioneer Natural is expected to pay off its debt by the end of this year, and will return billions to shareholders, Kiley said. Pioneer Natural CEO Scott Sheffield told CNBC recently that the company is giving back 80% of its free cash flow to investors through dividends and share buybacks. Kiley said one stock he likes is Cheniere Energy, the LNG exporter. "They're running full tilt. I expect them to put out good numbers when they announce in February," he said. "Names that are really out of favor, like Plains All American, they are generating a ton of free cash flow with the intent to return it to shareholders." He also likes Exxon Mobil which he says has been undervalued, and is not being credited for its core businesses. "We like what they're doing on the energy evolution front. The real core business there are exposed to the production of oil and natural gas and the products that are refined from them. That is clearly a recovery story with the exception of jet fuel." Safe haven? With investors looking to jump into the value, or the cyclical trade, energy appears to be a potential bastion of safety. "They're one of the last pillars that are still holding with higher oil prices," said Scott Redler, chief strategic officer of T3Live.com. "Some are worried if this really spills to the S & P 500, there won't be that many places to hide, but energy is holding in right now. It's hard to trust with the S & P 500 5% off its highs, and it could be down 10% to 15%." Stewart Glickman, CFRA energy analyst, says the energy stocks have been behaving differently since so many companies are focused on rewarding shareholders rather than their former objective of increasing production with each jump in oil prices. "There's been so much pressure on oil companies not to throw too much money into the drill bit. In the past when they've done that they've been hammered," Glickman said. He said the broader transition to alternative fuels has encouraged that discipline, but now oil prices may make drilling more appealing. "Arguably the returns are there. That's something most E and Ps, when they've gingerly put their toe in the water, they've had their hands slapped. I'm going to be interested to see what happens in Q4 with budgets for next year," said Glickman. He noted even a 15% increase in cap ex spending would not make a dent in what type of spending reductions there have been. Glickman's buy list includes Devon Energy, ConocoPhillips , Exxon Mobil and Chevron. Companies in the S & P energy sector are expected to earn $28.1 billion in the fourth quarter, compared to a deficit of $300 million a year ago, according to Refinitiv. All five energy sub-sectors are expected to see higher earnings. Pickering said he does not expect to see public companies coming forward with big spending plans when they announce earnings. "All of our channel checks say the U.S. capital discipline story is in tact," he said. "Rig count is up, but it's much more driven by private companies than public. Public companies are sticking with this mantra." With fourth quarter earnings starting to roll in, the issue will be front and center against the backdrop of rising oil prices. "Investors are laser-focused on this," Pickering said. "The bigger issues are money is flowing back to the sector and the commodity has a floor under it - those two things together with the stocks being pretty cheap." Among the companies Pickering likes are Devon, Diamondback and Schlumberger , which reports earnings Friday.

A maze of crude oil pipes and valves is pictured during a tour by the Department of Energy at the Strategic Petroleum Reserve in Freeport, Texas, June 9, 2016.

Richard Carson | Reuters

The stock market has struggled this month, but the old-line energy stocks that drill for oil and gas have made double digit gains and could continue to outperform in 2022, analysts say.