Consolidation Won't Drive This Energy ETF and That's Alright | ETF Trends

In bygone eras of energy sector ebullience, mergers and acquisitions were commons. These days, with markets prizing dividend defense and strong balance sheets, investors shouldn’t expect consolidation to be an upside catalyst for the sector.

For investors holding or considering the FlexShares Morningstar Global Upstream Natural Resource Index Fund (NYSEArca: GUNR), the lack of mergers and acquisitions activity isn’t a drag. It’s a plus.

GUNR specifically identifies upstream natural resources equities based on a Morningstar industry classification system, with a balanced exposure to three traditional natural resource sectors, including agriculture, energy, and metals. With some wild moves in downtrodden energy stocks, the gambling element of energy investing is back, but investors can take some risk out of the equation with GUNR.

“One solution is for larger more-efficient operators to buy up competitors, consolidating the industry,” reports Avi Salzman for Barron’s. “That way they can lower the overall cost of production and convince investors and lenders that the companies are worth an investment. And given that most oil-and-gas companies are down 30% or more this year, acquisitions can presumably be completed at a bargain. For Big Oil, this could be a chance to get bigger, on the cheap.”

Allure of GUNR

GUNR provides exposure to the rising demand for natural resources and tracks global companies in the energy, metals, and agriculture sectors while maintaining a core exposure to the timberlands and water resources sectors, which is a part of the risk management theme.

“There are few signs so far that mergers are on the horizon. Investors are rewarding cautious oil-and-gas companies that are using their cash to sustain their balance sheet or make sure they can keep paying dividends,” according to Barron’s. “Mergers and acquisitions would divert that cash to other purposes. Cowen analysts said in a report on Thursday that the next age of consolidation—aside from a few isolated incidents—will likely have to wait.”

With the economy reopening following the coronavirus shutdown, GUNR could offer more near-term upside. Some data points indicate sell-side analysts remain bullish on energy stocks, including some GUNR components. Valuation may be one reason why. The recent sell-off may have opened up a potential buying opportunity for bargain hunters, especially in the oversold energy sector. History says don’t bet on energy sector M&A anytime soon.

“The Cowen team, led by Jason Gabelman, wrote that the acquisitions completed since the last downturn in 2014-16 have mostly turned out badly and likely made energy executives gun-shy about rolling the dice again,” reports Barron’s.

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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.