Income Investors Are Returning To Oil And Gas Stocks

Some investors have started to see oil and gas stocks as income investment stocks rather than boom-and-bust cyclical stocks, as many others still believe. 

Record cash flows and profits of the past two quarters have prompted many oil and gas firms to boost dividends or pay special variable dividends, as is the case with U.S. shale producers.

Many more expanded and increased their share buyback programs. The record profits and the cash flow bonanza could lay the foundations for more stable dividend payouts to shareholders, some investors believe.

But others continue to see the industry as a cyclical business that slashes dividends when oil prices plunge.

The question for all investors going forward will be whether the industry will continue to keep disciplined spending and use more of its cash flows to reward shareholders. Oil firms have pledged this much over the past two quarters, looking to attract investors and pay current shareholders who have stuck with their stocks through thick and thin over the past few years.

But what will oil companies do during the next bust? Will they be able to keep the current policy of rewarding shareholders more? Or will they resort – once again – to slashing or suspending dividends, as they did in the two major oil price busts of the past decade?

“The industry has seen a permanent transition to almost a high-yield, income space,” Morningstar analyst David Meats told Bloomberg while noting that the almost income-investment profile of oil stocks is unlikely to persist. The current high dividend yields could be seen as a risk premium for investors for the cyclical nature of the stocks, Meats said.

Right now, oil stocks are looking attractive by some metrics. Analysts say that energy stocks are much cheaper than other sectors based on forward-year price-to-earnings (P/E) ratios.

Year to date, the energy sector has been the top-performing sector in the S&P 500 index, according to market data compiled by Yardeni Research.

The energy sector in the S&P 500 had gained 31.9% year to date to September 29. In comparison, S&P 500 is down 23.6%, and all other sectors have also lost ground since January.

Equity strategists, portfolio managers, and retail investors have grown increasingly bullish on energy stocks, the latest Bloomberg MLIV Pulse survey carried out in early September shows.

The poll of 814 respondents—including retail and portfolio investors, risk managers, buy-side and sell-side traders, equity strategists, and economists—showed that two-thirds of all respondents intended to increase their exposure to energy-related stocks and bonds over the next six months.

Moreover, nearly half—or 44%—of respondents say the current price of oil doesn’t adequately reflect actual supply and demand.

Stocks could remain attractive in the medium term, too, some analysts say.

“With the average company approaching “debt free” status by early 2023 their ability to increase shareholder returns in the form of dividends and buybacks may be much greater,” Eric Nuttall, Senior Portfolio Manager at Ninepoint Partners, said this week.

“Even with the rally earlier this year, energy stocks remained inexpensive and failed to even moderately embed an oil price above $100,” Nuttall added.

Stacey Morris, head of energy research at VettaFi, commented in mid-September on the observation that “energy stocks and oil happily decouple.”

“Oil prices typically dictate the direction of energy stocks, but thankfully for energy investors, that has not been the case over the last several weeks. Oil prices have seen three straight months of price declines and are down more than 30% from their relative high in June, but one may not realize that by looking at energy stock performance,” Morris said.

And she asked the million-dollar question: “Are investors finally looking past the volatility in oil prices to the actual merits of energy companies and the way they are returning cash to investors?”