Oil has come down slightly after a very strong start to 2018, but there are reasons to be bullish on energy beyond commodity prices, says Peter Hardy, vice-president and client portfolio manager at American Century Investments in Kansas City, Missouri.
“We evaluate these companies as businesses and look at their long-term returns potential,” said Hardy, whose firm manages the Renaissance U.S. Equity Income Fund, in a mid-December interview. He also looks at their cash flow potential, through a cycle.
“By virtue of that, we tend to be less focused on the underlying commodity price and more focused on what we think these businesses can achieve on a go-forward basis,” says Hardy.
Looking at today’s underlying commodity price alone is likely comforting for holders of energy names; both Brent Crude and West Texas Intermediate reached three-year highs during the week of Jan.12, and closed at US$68.61 and US$63.37 on Friday.
This general pickup in oil prices comes after the Organization of the Petroleum Exporting Countries (OPEC) and Russia agreed to continue to curb production through 2018. The cuts came in response to an oversupply since 2014. Global economic growth has pushed oil prices up more than 50% in just over half a year.
“From a supply-demand fundamental perspective, the commodity price has experienced gains. However, when you look at many of the names in the energy sector, a lot of them have had negative double-digit returns,” Hardy said in December.
He says energy companies have earned good money at more modest prices in the past.
“There’s a cost-side of the equation that investors tend to overlook,” he says. Finding companies whose costs are being contained should allow for normal revenue generation even if commodity prices are lower.
In its monthly report for January, the International Energy Agency (IEA) warned that increasing U.S. production could outweigh declines elsewhere and put downward pressure on prices.
Looking back, the energy sector’s low returns last year stand out in a bull run that saw massive gains in several markets.
“Energy as a sector has underperformed the performance of the underlying commodity price, and underperformed the broad market in general,” Hardy says. “Because of that, the names appear very attractive to us on a valuation basis.”
The energy sector is a more cyclical space and, therefore, a more volatile one, he adds. However, “because of the attractiveness of the names from a risk-return or valuation perspective, we’re overweight the sector,” Hardy said during his December interview.
This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.