Oil services-related exchange traded funds are among the hardest hit after the plunge in energy prices. For the more risk-tolerant investor, the pullback presents a potential value play on a beleaguered sector.
For instance, the Market Vectors Oil Service ETF (NYSEArca: OIH) has declined 21.8% over the past year. Consequently, OIH is currently trading at an 18% discount, according to Morningstar analyst John Gabriel. [Oil Playing a Dirge for Energy Services ETFs]
The oil services ETF shows a price-to-earnings of 12.6, compared to the 17.3 P/E of the SPDR S&P 500 ETF (NYSEArca: SPY).
While oil services stocks look cheap as a long-term play, Gabriel warns that short-term volatility could send OIH lower over the next 12 to 18 months before it settles into equilibrium – companies can not shut down operations overnight and production is expected to rise on increased efficiency and contractual obligations.
However, if energy prices begin to inch higher and oil drilling operations expand, the oil services industry will strengthen as they provided the necessary expertise and equipment to tap into ever hard-to-reach areas to extract oil, such as the push into deep offshore wells.
Additionally, potential investors should keep in mind that the oil services sector is heavily reliant on capital spending cycles in the energy industry. The recent sharp cuts in capital expenditure budgets in 2015 contributed to the pullback in oil services – U.S. companies are expected to spend about 20% less than the average over 2014, with some cutting expenditures by around 50%.
“The investment thesis for taking a stake in OIH is likely motivated by the fact that the incremental barrel of oil being produced is increasingly coming from areas (deep water, oil shale, the Arctic) that demand more services expertise and technology,” Gabriel said. “Such a dynamic supports healthy long-term industry trends and pricing power. However, prospective investors should also keep in mind that oil-services firms do tend to move in a somewhat outsized fashion depending on which way the economic winds are blowing.”
OIH holds 25 of the largest companies in the space and includes a large tilt toward Schlumberger (NYSE: SLB) and Halliburton (NYSE: HAL).
Alternatively, the iShares U.S. Oil Equipment & Services ETF (NYSEArca: IEZ) provides a slightly more diversified portfolio of about 50 companies, but it is still top heavy. Additionally, the SPDR Oil & Gas Equipment & Services ETF (NYSEArca: XES) equally weights a portfolio of about 50 oil services companies.
For more information on the energy services sector, visit our oil services category.
Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own shares of SPY.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.