Searching For Value In The Oil Patch

In what has been a brutal year for energy stocks, some energy sub-industries have been notably worse than the broader group, which is heavily tilted toward integrated oil names. For example, exploration and production and oil services stocks have performed notably worse than integrated oil names and refiners.

Making matters worse is volatility. As in oil services, ETFs are more volatile than traditional, diversified energy sector ETFs. This year, oil services ETFs, such as the Market Vectors Oil Services ETF OIH and the iShares U.S. Oil Equipment & Services ETF IEZ, have been noticeably more volatile than broader energy sector ETFs, such as the Energy Select Sector SPDR XLE. 

Even with energy equities mired in a slump and heading for another year of lagging the S&P 500, contracting earnings mean the sector is not as inexpensive as some investors would like to believe. Energy stocks, broadly speaking, are not really cheap at all. However, the sector still offers pockets of opportunity for long-term investors.

"There are two places in particular investors underweight the energy sector may want to start looking to add positions: U.S. drillers levered to low cost production sites and midstream MLPs," said BlackRock Global Chief Investment Strategist Russ Koesterich in a recent note. 

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The $248.7 million IEZ is down more than 30 percent this year-to-date. Although weekly rig counts have recently ticked higher, global oil giants are scrapping billions of worth projects, meaning some pain for oil services. However, a case can be made that with a two-year loss of 45.3 percent, IEZ has already been adequately punished.

IEZ, which is 9 1/2 years old and home to 42 stocks, has a price-to-earnings ratio of just 9.77, according to iShares data. That is barely more than half the P/E on the S&P 500.

The ETF's largest holdings include, Schlumberger NV SLB (the world's largest oil services company), Halliburton HAL and Baker Hughes Inc. BHI. Halliburton is trying to acquire Baker Hughes, though that deal has some regulatory rough patches. National Oilwell Varco Inc. NOV, IEZ's fourth-largest holding, has been rumored to be a potential acquirer or a potential target.

"The cratering in oil prices is hurting any and all energy companies, but I believe those with lower production costs, such as Exploration & Production companies focused in the Permian Basin in west Texas, are better positioned to ride out a period of depressed oil prices," adds Koesterich.

Many of IEZ's largest holdings have significant exposure to major ex-U.S. oil producing countries, where production costs are well below those seen in the States.