The ‘attractive opportunity’ in undervalued energy stocks
US energy stocks look ‘very attractive’, according to Allan Gray, as the sector hits a 30-year low relative to the broader share market.
Over one year to 30 September, 2019, the S&P 500 Energy Sector has lost 14.7% in Australian dollar terms versus returns of 11.9% by the broader S&P 500, according to FE Analytics.
The index was trading at a 30-year low relative to the broader index and many energy companies were struggling to make adequate returns.
Speaking at an Allan Gray & Orbis investor conference in Brisbane, Allan Gray portfolio manager Dr Suhas Nayak said he found this underperformance an attractive entry point and he already had 20% of the Australia Equity fund invested in that space.
“Allan Gray finds energy stocks very attractive. There is always a risk to any investment but we weigh up whether we can be compensated for the risk by buying at a low enough price,” Gray said.
“Even if a few things go wrong for our energy stocks going forward, we believe they can still generate reasonable returns. But the upside could be significant if a few things go right. This asymmetric payoff profile, repeated in many stocks, can help the portfolio deliver outperformance.”
He said sentiment to the sector had been ‘soured’ by factors such as low-cost US shale, inventory builds, electric vehicles and speculation over climate change.
He was also a fan of the materials sector with the fund having over half of its assets invested in energy and materials combined, as he felt these type of cyclical stocks were a ‘pocket of value’. As a result of the value on offer, he was adding to cyclicals while reducing the allocation to defensives.
“We see good pockets of value in cyclical stocks, particularly in the energy and materials sectors. The valuation disparity between cyclical stocks and defensive stocks such as healthcare and utilities, is the widest we’ve seen for years. Investors are chasing companies with low-volatility earnings streams,” he said.
“But this large valuation disparity means many cyclical stocks are now significantly undervalued. As a result, for over a year, we have been increasing our exposure to cyclical companies and reducing our exposure to defensives.”
Performance of S&P 500 Energy sector versus S&P 500 over one year to 30 September, 2019.
AUTHOR
Laura Dew
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