Avoid Oil And Gas Equipment And Services ETFs, But Consider These Stocks

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Includes: BHGE, CLB, DO, ESV, FTI, HAL, HP, IEZ, NE, NOV, OIH, PXJ, RDC, RIG, SDRL, SLB, XES, XOP
by: Steve Auger
Summary

Four ETFs address the oil and gas equipment and services industry, including OIH, XES, IEZ, and PXJ. OIH and IEZ had the best five-year performance.

OIH and IEZ both track market-cap-weighted indices and explains why their performance has been better than XEX and PXJ, which are not market-cap-weighted.

Analysis of the aggregate fundamentals for OIH indicate that the equipment and services subindustry component of OIH has lofty valuations. On the other hand, the drilling subsector has normal valuations.

It was stated in a previous article that the prognosis for crude oil is not good. If the reader wishes to invest in this industry, then ETFs should be avoided.

The following oil and gas drilling stocks should be evaluated further for possible investment: DO, NE, RDC, and RIG.

Recently, I wrote an article that examined the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP). Today, I am moving on a different aspect of the oil and gas industry: equipment and services. There are four ETFs covering this industry, including VanEck Vectors Oil Services ETF (NYSEARCA:OIH), SPDR S&P Oil & Gas Equipment & Services ETF (NYSEARCA:XES), iShares U.S. Oil Equipment & Services ETF (NYSEARCA:IEZ), and PowerShares Dynamic Oil & Gas Services Portfolio ETF (NYSEARCA:PXJ).

Fund

Expense Ratio

Index

OIH

0.35%

MVIS US Listed Oil Services 25 Index

XES

0.35%

S&P Oil & Gas Equipment & Services Select Industry Index

IEZ

0.44%

Dow Jones U.S. Select Oil Equipment & Services Index

PXJ

0.63%

Dynamic Oil & Gas Services Intellidex Index

OIH and XES are tied with the lowest expense ratio of 0.35%, while PXJ has the highest at 0.63%. While each of the four ETFs track different indices, OIH and IEZ have outperformed their siblings over the last five years, primarily due to the fact that their associated indices are weighted by market cap as opposed to XES and PXJ, which are not. Market-cap-weighted portfolios generally have lower beta and perform better in down markets, whereas equal-weight portfolios perform better in up markets. The oil bear market which started in 2014 appears to have been the catalyst for the disparity in performance.

(Data source: Quote Media, Chart construction: MS Excel)

Top Ten Holdings

The price history for OIH tracks that of IEZ almost exactly. The reason is that both ETFs have almost identical holdings, with eight of the same stocks in the top ten. These include Schlumberger Limited (NYSE:SLB), Halliburton Company (NYSE:HAL), FMC Technologies, Inc. (NYSE:FTI), National Oilwell Varco, Inc. (NYSE:NOV), Baker Hughes Inc. (BHI), Core Laboratories (NYSE:CLB), Transocean Ltd. (NYSE:RIG), and Helmerich & Payne Inc. (NYSE:HP). Schlumberger has a weight of ~19% in both ETFs, which is probably the reason why the two ETFs have very similar performance.

(Sources: VanEck.com, iShares.com)

As mentioned before, XES and PXJ holdings are not weighted by market cap. XES holdings are equal-weight while the stock selections and weighting for PXJ are based on a variety of criteria, including price momentum, earnings momentum, quality, management action, and value.

(Sources: spdrs.com, invesco.com)

Fundamentals

For fundamentals, I decided to analyze OIH given that this ETF has a low expense ratio and best performance over the last five years.

One of the nice things about ETFs is that the ETF provider has to publish the list of securities held by the ETF on a regular basis. I downloaded the list of stock symbols for OIH from the VanEck website and created a "custom list" on my favorite quantitative investment tool, Portfolio123. With Portfolio123 a custom series can be generated for just about any aggregate fundamental extracted from a list of stocks. Note that for aggregates, I am using the median value from the cross-section of stocks in the custom list. The median value works best, as it isn't skewed by one or two outliers with far off values.

While performing this exercise, I discovered something very interesting by separately plotting the 16 stocks identified as oil and gas equipment and services from the nine stocks classified as oil and gas drilling.

(Data Source: Portfolio123, Charting Tool: MS Excel)

The equipment and services stocks are clearly exhibiting frothy valuations unlike anything seen in the last 10 years, whereas oil and gas drilling stocks have quite reasonable valuations. This phenomenon applies to both price/cash flow and EV/EBITDA.

(Data Source: Portfolio123, Charting Tool: MS Excel)

Individual Stocks for Further Study

Unfortunately, there are no ETFs that specialize in oil and gas drilling. The future performance of the energy equipment and services industry is dependent on where the price of oil is headed. In my previous article, I stated that the price of oil is likely headed lower due to rising interest rates and the crude oil COT report. However, if the reader believes that the future is bright for oil, then I suggest avoiding OIH and the other oil and gas equipment and services ETFs altogether and consider only investing in oil and gas drilling stocks. The following is the list of oil and gas drilling stocks held by OIH.

Name

Debt/Equity

Price/Cash Flow

Diamond Offshore Drilling Inc. (NYSE:DO)

0.56

5.31

Ensco PLC (NYSE:ESV)

0.67

48.25

Helmerich & Payne Inc.

0.11

NA

Nabors Industries Ltd.

0.98

NA

Noble Corporation plc (NYSE:NE)

0.63

3.78

Patterson-UTI Energy, Inc.

0.3

96.07

Rowan Companies plc (NYSE:RDC)

0.52

2.72

Transocean Ltd.

0.55

3.39

Seadrill Limited (NYSE:SDRL)

1.1

0.58

(Data Source: Portfolio123)

DO, NE, RDC, and RIG have relatively low debt/equity and low price/cash flow and are worthy of further study.

Wrap-Up

Four ETFs address the oil and gas equipment and services industry, including OIH, XES, IEZ, and PXJ. OIH and IEZ had the best five-year performance. OIH and IEZ both track market-cap-weighted indices and explains why their performance has been better than XEX and PXJ, which are not market-cap-weighted. Analysis of the aggregate fundamentals for OIH indicate that the equipment and services subindustry component of OIH has lofty valuations. On the other hand, the drilling subsector has normal valuations. It was stated in a previous article that the prognosis for crude oil is not good. If the reader wishes to invest in this industry, then it is suggested that the oil and gas equipment and services ETFs be avoided completely and the following oil and gas drilling stocks be evaluated further: DO, NE, RDC, and RIG.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.