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A Dozen Stocks to Play an Energy Sector ReboundA Dozen Stocks to Play an Energy Sector ReboundBarron's (Online); New York Energy stocks fell much harder than the broader market last week, probably because the stocks had risen so dramatically over the first five months of the year. The Energy Select Sector SPDR exchange-traded fund (ticker: XLE) was down 17% on the week, and the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) fell 20%, versus a 5.8% drop for the S&P 500. The ETFs were rising on Tuesday, with the Energy Select fund rebounding 5%. West Texas Intermediate oil futures (WTI) were up 2.3%, to $112.13 per barrel. The weakness in energy last week makes some sense, given aggressive Federal Reserve action and growing recession fears . Energy is vulnerable during recessions because people use less fuel when the economy crashes. But several analysts are arguing that the drop—which erased nearly all of the sector's gains since Russia invaded Ukraine—was much too severe for an industry that's still poised to persevere through difficult economic times. The selloff was particularly notable because the drop in the stock prices far outpaced the drop in the price of oil, noted Morgan Stanley analyst Devin McDermott. The stock action was equivalent to oil prices falling $30 per barrel, as opposed to the $10 per barrel they actually fell. In fact, the stocks are now so cheap that it appears investors are pricing in a much more severe drop in oil prices ahead. Producers are trading at a 60% discount to the broader market, and Big Oil is trading at a 50% discount. "This is wider than nearly any time in the past decade," McDermott wrote. "Intrinsically, we estimate that the sector is now only pricing about $63 per barrel WTI—a steep discount to the futures curve." Even the most bearish oil analysts don't see prices hitting that level soon. Oil and gas stocks have mixed records in past recessions, sometimes outperforming the broader market and sometimes lagging. One important factor is whether the industry is in strong fundamental shape heading into the downturn. That's a good sign for the stocks now, given that most have stronger balance sheets than they have had in years. Still, McDermott thinks companies with scale, strong balance sheets, and well-supported buyback programs can outperform. His favorites include Exxon Mobil (XOM), ConocoPhillips (COP), and Diamondback Energy (FANG). He also likes Canadian producer Suncor Energy (SU). Buyback programs are one of the biggest reasons that oil and gas stocks should be OK, argues Tudor Pickering Holt analyst Matt Portillo. "Unlike prior cycles, pristine balance sheets should allow the industry to aggressively defend stocks on pullbacks with buybacks funded via free cash flow," Portillo wrote. Among the companies that Portillo thinks are in good shape to support their shares with buybacks are APA Corp. (APA), Antero Resources (AR), EQT (EQT), Marathon Oil (MRO), Ovintiv (OVV), PDC Energy (PDCE), ARC Resources (ARX), Enerplus (ERF), and Suncor. |
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