report gains in the coming week, but investors have more to worry than about hitting their numbers.
After a decade of underperformance, energy stocks led the market higher in 2021, averaging 30%. But on Thursday, an analyst, Gordon Gray of HSBC, threw in the towel on large oil inventories, lowering Chevron (ticker: CVX),
Royal Dutch Shell
(E) to keep from buying. His concern: This could be as good as it gets.
The problem starts with the transition to sustainable energy. Large oil companies are doing what they can, large European ones such as Shell buying wind and solar energy projects, and American ones investing in technologies such as carbon capture and storage. But they are moving slowly, so investors better invest elsewhere to play clean energy themes.
“[It] is far too early for many investors to consider playing on the transition theme,” Gray wrote. “Our analysis shows that oil companies are at least a decade behind utilities and autos in relative exposure to clean energy.”
Investors want oil companies to invest in renewable energy, but they are also concerned about the returns of those companies. While Gray thinks those concerns are exaggerated, he expects they will weigh on the stock. His only buy recommendation is now on the French energy giant
(TTE), which has a high dividend and is making a particularly rapid transition to renewable energy.
Gray acknowledges that the companies have improved in terms of cash generation and consistent profits. They’re spending more on debt reduction and dividends rather than expensive, low-yield projects like they did in the past — and they’ve been rewarded for it. Those days seem to be over, though. Shares haven’t even taken a hit from the latest oil price hike, not even falling relative to the overall market during the last $20 rise in Brent crude oil prices.
The big oil companies “have more downside sensitivity than upside sensitivity,” Gray says. “Put simply, stocks are likely to underperform the market in both directions at the moment: the oil majors fall more than the market when market indices fall and rise less when the market rises.”
Some will argue that the stock looks cheap. For example, Exxon (XOM) is trading at 12.8 times forward 12-month earnings, below the five-year average of 25.7, while Chevron is trading 14.2 times, below the average of 32.1 times. But rapid changes can make valuing an industry difficult, and while stocks may look cheap, it’s hard to know what the “correct” multiple is when an industry is shrinking rapidly, Gray says.
Gray’s perspective is one of the bleakest on Wall Street. Other analysts still like many major oil stocks and see energy as one of the better sectors for the second half of the year. JP Morgan analyst Phil Gresh says the energy sector should outperform the S&P 500 for the remainder of the year as demand continues to pick up along with travel. One of his favorite stocks is Exxon, which he believes can quickly pay off debt if it sells assets and sees its core returns improve. He puts it at Overweight with a price target of $74, up 30% from Friday’s close at $57.04.
Exxon is expected to report earnings of $1.01 per share on revenue of $64.6 billion, while Chevron is expected to report earnings of $1.59 on revenue of $36.3 billion.
Beats would be great. But keep a close eye on what the companies are saying about renewable energy. It could surpass everything else.
Write to Avi Salzman at email@example.com