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Oil Shares at Deepest Discount Signal Recession’s End

Bloomberg

By Rita Nazareth and Michael Tsang

July 20 (Bloomberg) — The cheapest valuations in at least 14 years are making oil companies too alluring to pass up for UBS AG and Guggenheim Partners LLC, even though earnings in the industry may fall 48 percent this year.

Oil and gas producers in the MSCI World Index traded at $7.84 per dollar of profit this month, less than half the average of $17.10 in the gauge of developed markets and the widest gap since at least 1995, data compiled by Bloomberg show. UBS, Guggenheim and Cohen & Steers Inc. are buying stocks from Exxon Mobil Corp. to Transocean Ltd. because an economic rebound will lift the industry after it generated at least 50 percent more profits than any other group in the past year.

Recovering energy shares may signal an end to the 42 percent drop in the MSCI World since October 2007 and the first global contraction in six decades. Rallies in oil and gas stocks marked the end of the last five U.S. recessions based on average returns, according to Ned Davis Research Inc.

“Energy will be one of the industries that lead us out,” said Scott Minerd, who oversees more than $100 billion as chief investment officer at Guggenheim in Santa Monica, California. “Shares are cheap and attractive. It’s a very good time for investors to buy the group betting on stronger demand for commodities and a rebound in earnings

The MSCI World added 0.2 percent to 984.48 as of 6:53 a.m. in London, with a measure of energy shares in the index rising 0.3 percent. Crude oil climbed above $64 a barrel in electronic trading on the New York Mercantile Exchange.

Exxon, Chevron

Minerd is boosting holdings even as analysts predict the global slump in energy demand will cause per-share earnings at energy companies in the MSCI World to drop to $13.36 from $25.74 in 2008, share-adjusted data compiled by Bloomberg show.

Profits at Exxon Mobil and San Ramon, California-based Chevron Corp., the two biggest U.S. oil companies, and BP Plc, the second-largest in Europe, will fall at least 50 percent, according to per-share estimates compiled by Bloomberg. Exxon and Chevron reported record earnings last year, while BP’s was within 6 percent of an all-time high. Along with Royal Dutch Shell Plc, they made up four of the five most-profitable companies in developed countries during the past 12 months, data compiled by Bloomberg show.

Their shares are trading at the steepest discounts on record because investors are still shocked by the 78 percent plunge in crude prices. While oil is up 43 percent this year, it fell as low as $32.40 a barrel in New York on Dec. 19 from a record $147.27 one year ago.

‘Rear-View Mirror’

The Paris-based International Energy Agency estimates that the global recession will slash worldwide oil demand by 2.8 percent this year. Lower profits have prompted the Hague-based Shell, the largest oil company in Europe by market value, to put two refineries in northern Germany up for sale, and it may close or sell another plant in Montreal.

Without increased demand, energy shares won’t beat the stock market’s performance, said E. William Stone, who oversees $96 billion as chief investment strategist at PNC Financial Services Group Inc.’s wealth management unit in Philadelphia.

“Energy shares are not necessarily cheap, especially looking at the past 12 months of earnings,” said Stone. “You’re looking at the rear-view mirror at much higher oil prices. That may mislead you.”

Valuations for energy companies are 54 percent below the average for the MSCI World, almost twice the gap of any other group, according to data compiled by Bloomberg. On a per-share basis, energy companies generate almost 12 cents in profit for every shareholder dollar, the highest earnings yield among the 10 industries in the MSCI World.

Depressed Valuations

Exxon Mobil made $38.9 billion over the last four quarters and has never traded at a bigger discount to the world index’s average, data compiled by Bloomberg show. The second-largest company by market value fetches 9.35 times earnings, 49 percent less than the average for the benchmark of 23 nations.

Shares of Geneva-based Transocean, the world’s largest offshore driller, are valued at 5.19 times profit, a 72 percent discount to the MSCI World. That’s close to the widest gap since at least 1995, the data show.

Those are bargains, said Mike Ryan, the New York-based head of wealth management research for the Americas at UBS Financial Services Inc., which oversees $590 billion.

“Energy shares were at depressed levels,” said Ryan. “As the economy gains some traction, commodity prices will recover and that will support the energy market and energy stocks.”

Global Rebound

UBS Financial, part of Zurich-based UBS, Switzerland’s largest bank by assets, has its biggest “overweight” position in energy stocks, compared with investments in each of the 10 industry groups in the Standard & Poor’s 500 Index, he said.

Faster growth in emerging markets and a recovery in industrialized nations will increase demand, profits and stock prices, said John Praveen, the chief investment strategist at Newark, New Jersey-based Prudential International Investments Advisers LLC, a unit of Prudential, which oversees $542 billion.

The world economy will expand 2.5 percent next year after contracting 1.4 percent in 2009, according to an estimate by the International Monetary Fund on July 8. Emerging and developing economies will grow 1.5 percent this year and 4.7 percent in 2010, the Washington-based lender said. China, the world’s third-largest economy, grew 7.9 percent in the second quarter, the government’s statistics bureau said July 16.

“We’re overweight energy not just based on valuations, but also based on macro factors,” Praveen said. His firm raised its allocation to energy shares last month to “overweight” from “underweight” and likes companies such as Houston-based Halliburton Co., the second-largest oilfield-services provider.

Looking Ahead

Crude oil will average $85 a barrel next year, according to Morgan Stanley, which lifted its estimate by 31 percent last week. The New York-based bank’s forecast is higher than the fuel has traded in any full year except 2008, when it averaged $99.75, according to data compiled by Bloomberg.

Analysts have increased their 2010 profit estimates for the five largest energy companies in the MSCI World from their April and May troughs, according to data compiled by Bloomberg. The consensus forecast for Irving, Texas-based Exxon Mobil’s 2010 adjusted earnings climbed to $6.04 a share last week from a low of $5.64 in May.

Oil stocks rose for the first time in five weeks in the period ended July 17, jumping 8.4 percent for a gain of 5.6 percent this year. The MSCI World has added 6.8 percent in 2009.

“We’re looking out into next year,” said Richard Helm, Seattle-based portfolio manager at Cohen & Steers, which oversees $16.3 billion. “Given the cash flow they generate and the earnings power that they have, shares are attractively priced here.” Helm bought Exxon stock last quarter, and the company is now the biggest holding in his Cohen & Steers Dividend Value Fund. Cohen & Steers is located in New York.

History Lesson

History shows that energy companies lead the U.S. stock market higher when economic growth resumes.

U.S. oil and gas producers gained 12.6 percent on average in the six months following the end of the past five contractions since 1975, the most among S&P 500 groups, data compiled by Venice, Florida-based Ned Davis Research show.

During the five-year bull market that ended in October 2007, energy stocks posted a total return of 256 percent as oil increased by 222 percent. That outpaced the MSCI World’s 168 percent gain, including dividends.

Dividends in the industry were the highest in five years versus the MSCI World on June 30, with the average company paying 3.44 percent of its share price to stockholders, according to quarterly data compiled by Bloomberg. The yield exceeds the average payout for the world index for the first time since December 2004.

‘Big Positive’

“That’s a big positive” that oil companies are able to maintain their dividends, said Thomas Deser, a Frankfurt-based fund manager at Union Investment, which had about $200 billion as of December 2008 and owns London-based BP, Total SA and Shell. “At the moment, the oil price is lower than it should be. Demand should pick up once the global economy comes back.”

Among non-financial companies in the 1,654-stock MSCI World, two — Paris-based Total and Shell — have at least $15 billion in reserves, are valued at less than 10 times earnings and pay at least 5 percent of their share value in dividends, data compiled by Bloomberg show.

Total, Europe’s third-largest oil company, trades for 9.3 times profit, about half the multiple of the MSCI World, data compiled by Bloomberg show. The company has a dividend yield of 5.91 percent.

The yield on London-traded Class A shares of Shell, Europe’s largest supplier, increased to 6.56 percent. Shell’s payout is the highest compared with the MSCI World since at least 2005, according to quarterly data compiled by Bloomberg.

“We’re starting to build back up again,” said Scott Richter, who helps oversee about $20 billion at Fifth Third Asset Management in Cleveland and bought shares of Transocean. “Now is the time to start positioning for the recovery.”

To contact the reporters on this story: Rita Nazareth in New York at [email protected]; Michael Tsang in New York at [email protected]

Last Updated: July 20, 2009 02:03 EDT

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