Oil Shares Gain Momentum Amid Supercycle Talk

Oil and gas shares have been a bright spot this year amid a sharp correction in equity markets. But they remain cheap on a historical basis considering the record free cash flow and big shareholder returns the sector is delivering. Energy security is rising up the political agenda, and some analysts and industry executives feel oil and gas has entered a new supercycle due to insufficient investment in supply. Still, there is no guarantee the sector “re-rates” to previous bumper multiples. Some investors think they have “missed the rally.” Others are likely to continue shunning the sector given its track record of poor returns and amid rising concerns surrounding climate risk and the energy transition’s impact on future oil and gas demand. US E&P stocks have outperformed the broader market by more than 60% year to date, with S&P’s Oil and Gas E&P Index up around 42% and the S&P 500 down about 23%. E&P executives are trying to convince investors that it is not too late to join the party, noting that valuations remain at historically low levels despite record free cash flow generation and rising dividends and stock buybacks. The energy sector’s weighting in the S&P 500 has risen two percentage points this year but remains at just 4.5%, compared to its historical average of 10%. Based on consensus analyst estimates for 2022, Devon Energy recently noted that its enterprise value to earnings before interest, depreciation and amortization (Ebitda) — a key cash flow measure — was just 4x compared to 13x for the S&P 500. Moreover, Devon is expected to deliver a 16% free cash flow yield and 8% dividend yield this year, compared to 5% and 1.5%, respectively, for the S&P 500.