This Sector ETF Is A Value Proposition

The energy sector has been one of the worst-performing groups dating back to 2014 and with that laggard status has come plenty of controversy. But give exchange traded funds such as the iShares U.S. Energy ETF IYE some credit because they are less bad than the S&P 500 to this point in 2016.

Year-to-date, IYE has outpaced the benchmark U.S. equity index by 70 basis points after plunging 22.2 percent last year. Part of the controversy surrounding IYE and rival energy stems from declining multiples and whether those lower valuations imply compelling deals or are merely the result of contracting earnings.

Some market participants see the energy sector as finally offering compelling value.

“The other universally unloved asset class is energy. While assessing “fair value” is always an elusive exercise when discussing commodities, the recent plunge in oil prices seems to have created value in energy-related companies. With energy firms’ earnings still plunging, their price-to-earnings (P/E) ratios don’t look very appealing,” said BlackRock Global Chief Investment Strategist Russ Koesterich in a recent note. 

Like rival equity-based energy ETFs, IYE is heavily allocated to integrated oil names with Dow components Exxon Mobil Corp. XOM and Chevron Corp. CVX, the two largest U.S. oil companies, combining for over 41 percent of the ETF's weight. Schlumberger SLB, widely viewed as the best of breed oil services name, is IYE's third-largest holding at a weight of 7.5 percent.

Beyond valuation, myriad factors affect energy ETFs. In the near-term, that includes the desire of major oil producing nations to move forward with production cuts. That is something Saudi Arabia and Russia, among others, have greeted in tepid fashion. Even if those countries do scale back output, there can be no guarantees U.S. shale producers will follow suit.

Still, it is hard to ignore how attractive major U.S. energy stocks are looking on a price-to-book basis.

“However, based on P/B measurements, the sector, as represented by the S&P 500 GIC Energy Sector, is trading at the lowest level of the past twenty years and at about a 45 percent discount to the broader U.S. equity market. Even assuming future write-downs, the current discount looks large,” adds Koesterich.