The energy sector’s tale of woe is well-documented, but the Energy Select Sector SPDR (NYSEArca: XLE) did gain 4.1% last week. XLE, the largest energy sector exchange traded fund, is still down 3.2% to start 2015 after losing 8.7% last year to finish 2014 as the worst performer among the nine sector SPDR ETFs.
Ahead of a major week of earnings reports, the energy sector, the seventh-largest sector weight in the S&P 500, faces an interesting problem: Valuation. Energy stocks, which during last year’s tumble were looking attractively valued relative to the S&P 500, now look expensive.
“The ratio of earnings expected for the next 12 months relative to price for the S&P 500 Energy sector stood at 22.4 times on Friday, its highest level since 2002. That compares with a 16.6 valuation for the S&P 500, which also is trading above its 10-year average of 14.1,” reports Kristen Scholer for the Wall Street Journal.
Not surprisingly, the energy sector, the worst performer in the S&P 500 last year, is expected to be an earnings season disappointment.
“The Energy sector currently has the highest number (14) and the highest percentage (33%) of companies with a Sharp estimate below the mean EPS estimate for the third quarter. At the sub-industry level, 11 of these 14 companies are in the Oil & Gas Exploration & Production sub-industry,” notes FactSet. [Sector ETFs for Earnings Surprises]
The energy sectors frothy valuations will be put to the test this week amid an avalanche of earnings updates from the group’s marquee constituents. Dow component Chevron (NYSE: CVX), XLE’s second-largest holding at 13.6% of the ETF’s weight, delivers results on Friday. That report is preceded by ConocoPhillips (NYSE: COP) and Occidental Petroleum (NYSE: OXY) on Thursday. ConocoPhillips and Occidental combine for over 7.2% of XLE’s weight.
With investors knowing that the fourth quarter was trying one for oil companies because of crude’s slide, the earnings issue will be more about what XLE’s constituents say about first-quarter profits. With the United States Oil Fund (NYSEArca: USO) down 16.5% year-to-date and having touched new multi-year lows last Friday, the outlook is murky. [Value in Oversold Oil ETFs]
“Those valuations are unlikely to come down as few think the price of oil has bottomed. That means energy companies are likely to see their earnings continue to shrink,” according to the Journal.
There is some hope for Exxon Mobil (NYSE: XOM) and Chevron, XLE’s two largest holdings and a combined 30.7% of the ETF’s weight.
Exxon and Chevron are also two of the largest oil refiners and refiners benefit when oil prices slide because lower oil prices reduce input costs for refiners, which can lead to higher margins. Exploration and production stocks are usually more sensitive to oil price fluctuations than their integrated counterparts, like Exxon and Chevron. [Waiting on an Energy Sector Rebound]
Energy Select Sector SPDR