Why oil and gas stocks are a bargainAngela Macdonald-Smith Sep 13, 2021
Investors turning their backs on oil and gas stocks risk missing out on an eventual recovery in the sector once the market wakes up to the huge gap that has built between soaring commodity prices, that will boost company profits, and depressed share prices.
Market sources point to a disconnect between share prices and oil and gas commodity prices that has been evident for months but is now becoming “ridiculous” given the buoyant LNG market and continuing robust crude oil prices, which are swelling cash flows for producers.
The heightened wariness of investors to environmental, social and governance (ESG) concerns in relation to natural gas is thought to be a big part of the problem.
But some are anticipating an inevitable catch-up that could see share prices surge 30 per cent or more in a short time as the market recognises the impact of higher prices on cash flows and earnings.
“You’ve got big uplifts coming through and where in this market can you find genuine earnings growth?” said Romana Sala Tenna at Katana Asset Management.
“Genuine earnings growth is a rarity – that’s why people are paying so much for technology stocks – so I think when we start to connect the dots and see the earnings growth coming through, it’s going to be too compelling for some investors.”
The Australian energy sector is “primed for a re-rating” despite the ESG headwinds, says JPMorgan energy analyst Mark Busuttil, who estimates that the sector is trading 50 per cent below the valuation implied by Brent oil prices.
Woodside’s share price is ‘mind-boggling’Asian spot LNG prices rose past $US20 per million British thermal units last week, according to Reuters, meaning they have risen ten-fold since their record lows just over a year ago.
Prices, which hit a low of less than $US2/MMBTU in the June quarter last year, could still head higher given the looming Northern Hemisphere winter, the peak buying season for LNG in major markets such as Japan, South Korea and China.
The global gas and LNG supply squeeze “sets the stage for record winter prices”, said Lindsay Schneider, an analyst and consultant at RBN Energy.
Meanwhile, Brent oil prices are trading at about $US73 a barrel, up from about $US40 about 12 months ago.
However, the share prices of the major oil and gas producers have failed to respond, unlike in past cycles.
Woodside has slid more than 20 per cent in the past six months, while Santos and Oil Search are down 10-15 per cent.
“It is astonishing; that Woodside’s share price is below $20 is in our opinion mind-boggling.” said Simon Mawhinney at value investor Allan Gray, which holds stakes in Woodside, Oil Search and Origin Energy.
“These companies would be making very, very significant amounts of money at the moment, which I feel is not at all factored into the share prices.”
Stock-specific factors are playing a part, with Woodside expected to issue almost 1 billion new shares to pay for the acquisition of BHP’s petroleum business under the $41 billion merger deal announced last month. That is expected to create a stock overhang as some BHP investors sell their allocation.
Santos and Oil Search, meanwhile, have agreed on their own scrip-based mergerthat is due to go before Oil Search shareholders in late November, in effect tying their share price movements to each other in the interim.
More broadly, analysts point to an escalation of environmental, social and governance issues affecting the sector amid heightened awareness about the climate impact of natural gas, which has been particularly evident this year.
But Mr Mawhinney said the sharp rally in coal stocks would suggest that the problem in the oil and gas sector was not just ESG related.
Five-year highs in prices for premium Australian coking coal and 10-year highs in thermal coal prices have propelled stocks such as Whitehaven Coal and Coronado Coal up more than 100 per cent since May in defiance of ESG pressures.
Still, Mr Sala Tenna said he still believed the issue was indeed mostly due to ESG factors, but that the coal sector was well ahead of gas in terms of the impact on the share register.
He said ESG investors had essentially already sold out of coal producers, leaving the stocks able to re-rate, whereas in oil and gas the shake-up of the shareholding base was still under way.
“Coal ran its course probably 12, 24 months ago, when a lot of the ESG-conscious and the ESG-focused funds headed for the door, and then you’re left with people who were prepared to pick that up as an investment,” Mr Sala Tenna said.
“I do think we’re seeing the ESG brunt being worn by the E&P [exploration and production] guys now.”
Low prices are driving M&A interestThe dislocation on energy stock prices is however most evident in Australia, and is largely absent in North America or Europe.
Mr Mawhinney put that down to the absence of Australian oil and gas producers in the key indices used by exchange-traded funds that are directing huge amounts of capital to cyclical companies such as petroleum producers in those other markets.
“So all of the money chasing these cyclical companies has bypassed many of these energy companies in Australia,” he said.
“There isn’t a ‘buyer’s strike’ overseas because these ETFs have attracted a lot of inflows, and that money has been used to buy some of these other energy companies.
“But that buyer strike still exists in Australia because none of that money has flowed into buying Australian shares not inside these ETFs.”
JPMorgan’s Mr Busuttil calculates that the relationship between energy equities and their underlying commodity prices broke down in January 2021.
But he said investors could not afford to ignore the sector given the low equity prices are driving increased M&A interest.www dot afr dot com/companies/energy/why-oil-and-gas-stocks-are-a-bargain-20210913-p58r59
