By The ETF Professor
The energy sector, the S&P 500's fifth-largest sector weight has been a solid performer this year with the Energy Select Sector SPDR (NYSEARCA:XLE) gaining 16.8 percent.
In a testament to the strength of U.S. equities to this point, XLE's performance trails that of the SPDR S&P 500 (NYSEARCA:SPY) by 70 basis points.
XLE's 16.8 percent gain is also just enough to be considered "middling" among the nine sector SPDR ETFs. The largest energy ETF ranks fifth among the SPDR funds and only recent retrenchment in the staples sector at the hands of rising interest rates has allowed XLE to ascend to the fifth spot.
The good news, particularly for long-term investors, is that many of the largest, most familiar U.S. oil companies remain consistent dividend boosters and the U.S. is producing more oil today than at anytime over the past several decades. By some estimates China will surpass the U.S. within the next several years as the world's largest oil importer and that has the potential to be another positive catalyst for energy ETFs.
"We remain more heavily weighted toward large-cap companies with oil exposure. We believe these companies carry less risk on the balance sheet and exhibit more conservative spending habits than smaller peers, where funding has been an issue as U.S. natural gas prices remain weak. After heavy M&A activity over the last several years, as integrated and national oil companies sought out new growth avenues and E&P's were in need of funding aid, we see continued strength in the global M&A environment," said S&P Capital IQ in a new research note.
S&P Capital IQ's positive outlook on large-cap oil names is fostered by the view that companies will continue shedding under-performing refining and marketing assets, something ConocoPhillips (NYSE:COP) and Marathon Oil (NYSE:MRO) previously did. The research firm also sees the potential for increased mergers and acquisitions activity over the next year.
"To enter the U.S. oil frenzy, many larger integrateds have had to go the M&A route as much of the acreage has been eaten up by the E&P's. Successful North American onshore exploration should keep M&A levels strong over the next 12 months, in our opinion. This continued activity is raising asset values at many of the top U.S. onshore plays (Permian Basin, Eagle Ford Shale, Bakken Shale, DJ Basin), benefiting valuations in the E&P group," said S&P Capital IQ.
Apache (NYSE:APA), an independent producer with a proclivity for deal-making, earns a five-star rating from S&P Capital IQ. The company recently announced the sale of some Egyptian assets and has previously been one of the more acquisitive names among independent oil producers. Apache earned a five-star rating from S&P Capital IQ as did Chevron (NYSE:CVX).
Chevron, the second-largest U.S. oil company, has frequently mentioned as a possible buyer of any number of small rivals due to its ample war chest, stagnant production and the risks associated with doing business in locations such as Angola, Nigeria and Russia. S&P has a four-star rating on Exxon Mobil (NYSE:XOM), the largest U.S. oil company.
Exxon and Chevron dominate the largest U.S. energy ETFs, including XLE, which S&P rates Overweight. The two Dow components combine for 30.6 percent of XLE's weight.
S&P Capital IQ also four-star ratings on ConocoPhillips, EOG Resources (NYSE:EOG) and Anadarko Petroleum (NYSE:APC), all of which are top-10 holdings in XLE. Anadarko is no stranger to takeover chatter, but with a market cap of $46.3 billion and a valuation that appears rich compared to rival Apache, that moment may have passed.
All of the aforementioned stocks are top-10 holdings in the $1.4 billion iShares U.S. Energy ETF (NYSEARCA:IYE), which has gained 15.5 percent this year and is also rated Overweight by S&P Captial IQ. Exxon, Chevron and ConocoPhillips combine for 40 percent of IYE's weight.
S&P Capital IQ also has a four-star rating on Occidental Petroleum (NYSE:OXY), though investors looking to to access that stock via an ETF should opt for the iShares U.S. Oil & Gas Exploration & Production ETF (NYSEARCA:IEO).
Although IEO was not mentioned in the S&P note, Occidental is the ETF's largest holding at 13.4 percent. Anadako, EOG and Apache combine for roughly another 22 percent of IEO. IEO is up nearly 22 percent this year and almost seven percent since it was highlighted as beneficiary of news that the obscenely compensated Ray Irani was leaving his role as Occidental's chairman.
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Disclosure: Author is long OXY.
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