Oil sector strategy
• Good earnings visibility and strong balance sheets should give the sector resilience in uncertain markets
• On IBES 2009e PE, the sector is trading at 10-year low. Its PE relative is at a 14% discount to the market, excluding financials. Its yield relative on the same basis is 145%
• Our strategists have an overweight stance on the oil sector because of its attractive valuation and defensive characteristics
The European oil sector currently trades on a PE (IBES 2009e) of 9.3x, close to a 10-year low. Relative to the market, it trades on a PE relative of 98%, close to fair value. However, the consensus numbers for the market show earnings rising by 10% annually for 2008-10e. HSBC’s equity strategists regard this as optimistic and believe that sub-5% growth is more likely. If so, then we believe that the sector’s underlying PE relative would be nearer 90%. Also, we believe that relative valuations are being distorted by the financial sectors. Excluding them from the calculation reduces the oil sector PE relative to 86%.
Although the sector has traded on a lower PE relative than it carries currently, we regard a 14% discount as attractive, especially as we believe that the downside risks to consensus forecasts for the market appear greater than for the oil sector.
Our European economists believe that 2008 will see at least one cut in European interest rates, something that is already factored into debt market expectations. In the uncertain market of the past six months, investors appear to have favoured companies with sustainable dividends backed by strong balance sheets and a reliable stream of earnings. We believe a cut in European interest rates would reinforce the attraction of defensive yield plays, including the oil sector.
Yields versus bonds
The yield on the European oil sector relative to a 30-year euro denominated bond is close to the top end of its 10-year range.
We believe that this should provide a degree of defensive support in uncertain markets.
The sector’s yield relative to the market is only 124%, which is towards the low end of its 10-year range. However, as with PE relatives, we believe excluding the high-yielding financial sector from the analysis probably gives a better underlying picture.
Excluding the financials pushes the oil sector’s yield relative up to 145%, which we see as attractive, especially given the industry’s ability to grow its dividends. One feature of the sector’s fourth-quarter results was that several companies pushed up their annual payout by material amounts. BP increased its dividend for calendar 2007 by 31% in dollar terms, Total by 23% (11% in euros) and Shell by 13%.
Our equity strategists continue to recommend a defensive/growth bias to portfolios, including an overweight stance in oils. We believe that the sector’s yield and PE relatives support this view, especially given the visibility of the group’s earnings. Although we see oil prices heading lower, we believe that OPEC should be able to show sufficient discipline to keep annual oil prices in the USD75-80 area for 2008 and 2009. Although we carry a USD 60 assumption for 2010, this reflects our view of the marginal cost of oil and so should be regarded more as a conservative ‘floor’ assumption.