Not Too Much C.R.E.A.M For This ETF

Cash ruled everything around the Wu Tang Clan, but it does not rule everything around some of the holdings in the iShares S&P Global Energy Sector (ETF) IXC. When oil prices started faltering over a year ago, a common response by many large U.S. and foreign integrated oil companies was to cut capital expenditures.

Some even delayed increasing dividends or halted buybacks. These cash-conserving efforts have not gone unnoticed by investors. Coupled with rebounding oil prices, the iShares Global Energy ETF is up 13.3 percent year-to-date, an advantage of 180 basis points over its US-focused counterpart, the iShares Dow Jones US Energy Sector (ETF) IYE.

IXC And Its Lineup

As its name implies, IXC is a global ETF, meaning it includes domestic and foreign oil companies. Dow components Exxon Mobil Corporation XOM and Chevron Corporation CVX, the two largest U.S. oil companies, combine for over a quarter of IXC's weight. Overall, U.S. stocks are 59 percent of the ETF's lineup.

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The potential problem for the ETF is the inability of some of its marquee European holdings to better generate free cash flow.

“European major oil and gas companies' 1H16 results indicate they are likely to generate large negative free cash flows (FCFs) for the full year as average oil prices remain lower than in 2015, Fitch Ratings says. This will push up leverage in the near term but we expect cash deficits to fall in 2017 as oil prices start to gradually recover and the majors progress with their cost-cutting initiatives,” said Fitch Ratings in a recent note.

Royal Dutch Shell plc (ADR) (NYSE: RDS-A) (NYSE: RDS-B), BP plc (ADR) BP, Eni SpA (ADR) E and Total SA (ADR) TOT recently delivered earnings that indicate the capital conservation efforts of those companies still are not enough to bolster cash flow.

That quartet comprises integral parts of IXC's roster. BP and Shell combine for about 14 percent of the ETF's weight France's Total and Italy's Eni combine for over seven percent of IXC's weight. With a little patience, IXC investors should realize the benefits of European oil majors efforts to bolster cash flow generation.

Looking Ahead

“According to our forecasts the majors should significantly improve their cash flow generation in 2017, with the average pre-dividend FCF turning positive and average post-dividend FCF improving to around minus USD5/bbl. This progress should be driven by a combination of slightly higher oil prices, further cost cutting and falling capex,” added Fitch.

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