Oil stocks look cheap based on the 2011 profit outlook and global growth
Politicians in Washington and cable TV pundits are fulminating over oil industry profits as the average price of a gallon of regular gas approaches $4 in the U.S. Meanwhile, President Barack Obama wants to repeal $46.2 billion of tax breaks for oil and gas producers over 10 years and instead invest in alternative energy. Time for investors to dial back on energy stocks?
Not really, say equity analysts and investors. U.S. oil industry profits continue to exceed expectations as the global economy recovers. On a price-to-earnings basis energy companies are trading at the lowest valuation of the 10 broad industry groups in the Standard & Poor's 500-stock index. In other words, today's stock prices may not fully reflect the high-powered profits analysts see for the sector in 2011. The 41 drillers, refiners, and oil-field service providers in the S&P 500 are projected to earn $134.8 billion this year, up 41 percent from 2010, based on analyst forecasts issued in April.
The sector probably earned $31 billion in the first quarter of this year, a 41 percent advance from the year before, according to Wall Street forecasts tracked by Bloomberg. Earnings upgrades reduced industry valuations to 11.7 times projected 2011 income, from 13.7 in March. "Multiples on energy stocks are very low, and the investment opportunity remains pretty good," says Brian Barish, who oversees $8 billion, including Chevron (CVX) shares, as president of Denver-based Cambiar Investors. His Cambiar Aggressive Value Fund beat 99 percent of its peers in the past year.
Civil strife in the Middle East and North Africa, combined with forecasts that 2012 will see the fastest U.S. economic growth in seven years, sent oil prices up 35 percent in the past year, to $103.88 a barrel on May 10, even after a 15 percent plunge in early May. With gasoline prices up 64 percent since August and the unemployment rate 1.1 percentage points below the 26-year high reached in 2009, industry profits are on a tear.
ExxonMobil (XOM) reported profit of almost $11 billion in the first quarter of 2011, a 69 percent increase over the same period in 2010. Even so, ExxonMobil, the world's largest company by market value, trades at 9.6 times projected 2011 earnings, less than its 23-year median of 15.5 based on reported results, according to data compiled by Bloomberg. Chevron, the second-largest U.S. energy company, trades at 8.2 times estimated income even after a 14 percent advance this year. The company beat analysts' first-quarter profit estimates on Apr. 29; sales rose 25 percent, to $60.3 billion.
President Obama and Democrats in Congress say the profit surge justifies ending tax breaks for oil companies. Obama's 2012 budget would repeal tax breaks for oil and gas producers to generate $18.3 billion in revenue over 10 years. "There is absolutely no reason to continue to subsidize the most profitable companies in the history of the world," Representative Edward J. Markey (D-Mass.), the top-ranking Democrat on the House Natural Resources Committee, said in an Apr. 28 statement. "What is good for the biggest oil companies isn't always what's good for American taxpayers."
Oil executives say such criticism on the tax issue is misguided. "We've paid a total of $59 billion in taxes over the past five years, and that's a significant part of government revenue as well as more than we've earned through our U.S. operations," says Alan Jeffers, an ExxonMobil spokesman. "Any claim that we're not paying our fair share of taxes is inaccurate." Chevron says losing the tax breaks would hurt the industry's global competitiveness. "Discriminatory taxes would put U.S.-based energy companies at a competitive disadvantage around the world and discourage development of domestic oil and gas resources," says Lloyd Avram, a Chevron spokesman.
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