Small Energy stocks have been hammered compared to medium and large ones. When I see something that looks out of whack, I try to take a look at it and understand it better. Often, there are good reasons for the changes in the relationship between various stocks, but often there aren't. Segmented buyers can often explain the discrepancy, and I believe that is the case here. In the graph below (click to enarge), I have plotted the YTD returns of all of the S&P 1500 Energy stocks by the logarithm of their market caps. As you can see, the log regression has a pretty good fit (and an R-squared of 19%). In reality, as you can see in the table below (click to enlarge), it is the medium-sized companies that are doing best.
I have gone on the record recently as being supportive of Energy and of Small-Cap (both for similar reasons - balance sheet), so naturally when I see the average small-cap Energy stock down 17% when medium and large ones are up, I get a little excited.
Let's get some perspective before continuing. The entire S&P 600 Energy sector has 24 companies with a total market capitalization of $13 billion, just marginally above the median S&P 500 company at $9.6 billion. So, we are dealing with a very different animal potentially. There are some other differences too. In the table above, I have listed some attributes, and clearly the S&P 600 is skewed more towards Services rather than E&P. While the median company has higher liabilities relative to trailing EBITDA (negative), you can look at the tables below and see that the S&P 600 companies relative to the S&P 500 companies have slightly more net debt relative to capital (also negative). Though not a favorable comparison, the differences aren't signficant. Offsetting this, though, is the valuation, with the S&P 600 companies trading below tangible book value and almost 1/2 the relative level of the S&P 500 companies. PE ratios are similar. All in all, while there are some differences that perhaps need further explanation, the stark performance difference doesn't make a lot of sense.
I believe that the universe of buyers is segmented. Most institutional money managers live in a bucket (not literally, but if this market keeps declining, maybe so) known as the "style bucket". They are restricted by market cap or growth/value segmentation among other attributes. While the overall fundamentals for an industry should translate roughly across the universe, the valuation sometimes doesn't. Before continuing, let's look at the three groups of stocks (click to enlarge):
The S&P 500 is overloaded with producers by number and by market cap. Interestingly, the very largest stocks among the producers are dragging down the group, particularly ExxonMobile (NYSE:XOM) and ConocoPhillips (NYSE:COP). Note that the service companies are almost all UP on the year, while the producers are split with a break-even on average (which is better than the average S&P 500 stock) (click on chart to enlarge).
The mid-cap stocks are rocking. Here, we see a shift towards more service companies, but still the E&P guys are the majority. Again, we see the service companies performing better on average. Note that the small E&P guys are getting hammered, but the average return is still zero for the group. In fact the average returns are similar for the S&P 500 and S&P 400 by group. The better absolute performance for the S&P 400 is a function of the large E&P guys bringing down the S&P 500 as well as a better "mix" for the S&P 400 (more service companies).
Ok, now it get's very interesting. Note our conclusions so far: Service is beating E&P, but the average E&P stock is still about unchanged on the year. For the S&P 600, which is heavily weighted towards service, we find the average service stock is down 7%, while the few E&P stocks (except Holly Corp. (HOC)) are getting crushed. While there could be some issues here like these are bad service companies, the downturn could hurt small companies more, etc., there is a lot of explanation necessary to justify this big difference. The E&P companies may have some issues, but I don't see it. But for the service companies, I don't see any major differences in the metrics compared to the S&P 400:
- PE lower
- FY2 estimate changes similar
- P/TB lower
- Net Debt/Cap lower
So, I want to be a buyer of the best looking names on this list. I have, in fact, bought one, my old friend Carbo Ceramics (NYSE:CRR), which I sold a little too early last year. As always, I publicly disclose my holdings. I also added CRR to my Top 20 Model Portfolio today, and I should note that I added Tidewater (NYSE:TDW) earlier this month to my Conservative Growth/Balanced Model Portfolio. Chevron (NYSE:CVX) is a member of both. Some of the other names that stand out in my opinon: Lufkin (NASDAQ:LUFK), and Matrix (NASDAQ:MTRX), though they are both up year-to-date, as well as Seacor (NYSE:CKH), Bristow (NYSE:BRS) and Gulf Island (NASDAQ:GIFI). As a caveat, I don't know these other companies very well. This list is intended as a tool for readers to use as part of their dilligence.
While I do believe that this opportunity is mainly a function of segmentation of buyers, I am open to other suggestions. Usually these situations correct in rather short order. I recall when I bought CRR last year that it had lagged its 3 largest customers, all of whom are much bigger, and I am hopeful that is the case today as well.
Disclosure: Long CRR (and long CRR, CVX and TDW in model portfolios)