Investors’ disdain for energy stocks remains unabated with the sector oversold, undervalued and undercrowded as evidenced by the NA energy sector weight lingering at all-time lows at ~3%. Industry headwinds are well understood, but sentiment that the sector is a value trap is so ingrained in the minds of investors that the only marginal buyers seem to be companies as suggested by the decline in share counts. Despite a decline of 13% in industry free cashflow (FCF) so far this year, the sector FCF yield is near 20%, which is a strong incentive for companies to buy back their stock. That said, we believe the cyclical energy sector offers a compelling reward-to-risk ratio here. While global oil consumption could be constrained by a resurgence in covid-19 cases, recent economic data keep showing sequential improvement (Figure 2). Also, we note that petrocurrencies such as the CDN$ and the NOK$ have rallied back to their pre-covid-19 level. Ditto for the CDS index on energy bonds, which is now showing a bullish gap with NA energy equities (Figure 3). In all, while there remain clouds looming above the energy sector, the 29% rout in energy stocks YTD appears excessive relative to the recovery in energy bonds and global economic data.
Figure 1
Figure 2
