There is only one undervalued sector left on the ASX, says...

There is only one undervalued sector left on the ASX, says Morningstar

A year into the market rebound, Morningstar thinks there’s only one sector on the ASX left undervalued – and it’s energy.

Why are ASX energy stocks undervalued?

Energy stocks continued to lag in the early stages of the market recovery as oil prices plunged (briefly falling below zero) and while oil price began to rise again, stocks finished 2020 30 per cent lower than they began.

But 2021 commenced with a 3 per cent pop in the first quarter and Morningstar analyst Mark Taylor thinks there’s more growth to come.

Taylor sees energy giants Beach Energy (ASX:BPT) and Woodside (ASX:WPL) as 40 per cent below their fair value.

“That’s fundamentally because I’m pricing in expansion projects that the market’s probably not crediting at the moment,” he explained to *.

Woodside is set to commission a second gas processing train to its Pluto plant in 2025 which will add 38 per cent more to its group output. It also expects a doubling in the gas volume to be delivered to energy company Uniper this year.

As for Beach, Taylor is tipping exploration success to be the catalyst as well as the Brent crude price.

What about oil prices?

While Taylor thinks oil prices could rise further and it could be a catalyst for growth in energy stocks, it will be difficult to occur without return of air travel to pre-COVID levels.

But he thinks this isn’t important for companies like Woodside, Santos (ASX:STO) and Oil Search (ASX:OSH).

“The LNG price they receive is contract linked to the Brent crude price forecast with a one quarter lag,” he explained.

“It is important that the oil price is strong and that will have a direct impact on the LNG price.

“However, my fair value estimates are based on a US$60 per barrel and the price is marginally above that level.

“I don’t need anything to happen to the oil price but it seems like the market needs that demand to come back into play before it’ll be comfortable crediting US$60 into fair value estimates to these stocks for whatever reason.”

Has ESG killed energy companies?

Taylor admits there might be some negative investor sentiment about oil and gas because of its greenhouse gas emissions.

But he personally disagrees.

“I think that’s misplaced because natural gas is going to be a huge part of rapidly reducing greenhouse gas emissions on the planet,” he said.

“Because it’ll replace coal and oil and has half the carbon emissions of coal and something like two-thirds the carbon emissions of oil.

“It’s a quick and effective way to get emissions down in the medium term far more quickly than renewable energy would be able to to do during its expansion phase.

“We think there’s going to be strong growth in gas demand that’ll underpin these companies being able to expand their LNG project capacities.”