Shhh… Wall Street is hiding a secret from you. The secret? Big Oil is beating Big Tech in 2024.
After finishing 2023 with a loss as the broader market soared, energy stocks have started 2024 with a sharp rally that has them beating the broader tech indexes this year.
How Energy Investors Are Winning
The Energy Select Sector SPDR Fund (XLE) was up more than 13% in the first quarter of 2024, while the Nasdaq-100 Index ($IUXX) gained just 8.7%. XLE is now up 16.4% year-to-date, while the tech-heavy Nasdaq-100 is up just under 7%.
Adding to that outperformance is the massive amounts of payouts that the large oil companies are making to their shareholders via dividends. In fact, oil supermajors returned more cash to shareholders than ever before in 2023, as management reined in spending on new projects to free up capital for dividends and buybacks.
Exxon Mobil (XOM), Chevron (CVX), TotalEnergies SE (TTE), BP PLC (BP), and Shell PLC (SHEL) spent $113.8 billion combined on 2023 dividends and share repurchases, despite a slump in oil prices. The payouts were more than 10% higher than a year earlier, when Russia's invasion of Ukraine pushed up oil prices and oil industry profits.
The 2023 return to shareholders was 76% higher than the average payout during the industry’s 2011-2014 heyday, when crude oil (CLK24) hovered above the $100 per barrel mark.
Why Energy Stocks?
Energy stocks’ valuations continue to trade at a historic discount to the S&P 500 Index ($SPX), with energy being the cheapest sector in the market. The market capitalization of semiconductor and artificial intelligence (AI) superpower Nvidia (NVDA) alone is bigger than the entire energy sector.
There is a certain irony here, in that the data centers behind AI are energy hogs. It seems like hardly a day goes by without forecasts of big increases in U.S. electricity consumption because of AI.
Logic says you can’t be long AI and short energy, but Wall Street is at the moment.
It’s interesting to take a look at the energy sector’s share of forecast S&P 500 earnings versus its weight in the index. At the end of 2019, both were aligned at roughly 4% each. But now, the energy sector’s share of earnings has jumped to more like 7%, while its weight in the index is below 4%.
The last time we saw a gap like that was in the run-up to 2014. Oil was over $100 a barrel and poised for a fall, taking earnings with it. Plus, the companies were overspending. Today, oil is at around $90 again - at its highest level since October - and the industry is paying out large amounts of capital instead of spending it.
Of all the supermajors, my favorite remains Shell.
Shell Stock Looks Cheap
Shell (SHEL) was born out of the 1907 alliance between Netherlands-based Royal Dutch Petroleum and U.K.-based Shell Transport and Trading Company. Today, Shell is one of the world’s largest integrated oil and gas companies, with operations in more than 70 countries. The company’s business is broken into several segments.
The Integrated Gas (49% of 2023 normalized earnings) business focuses on liquefying natural gas (LNG) for transport to customers around the world. The company is a global LNG leader, with sales of 67 million tons in 2023, and has some of the world’s largest and most advanced liquefaction/regasification plants, located in more than 10 countries.
Upstream operations (34%) mainly involve exploration and production activities that search for and recover oil and natural gas (NGK24) around the world. It has net proved hydrocarbon reserves of about 9.8 billion barrels of oil equivalent (boe), with 1.1 billion boe of production in 2022. Most of those reserves (44%) are located in Asia, with the remaining split 7% in Europe, 12% in Oceania, 6% in Africa, 16% in North America, and 15% in South America.
The Marketing segment (11%), the Chemical & Products segment (13%), and the Renewables and Energy Solutions (2%) make up the rest of Shell's earnings.
The company’s former CEO, Ben van Beurden, said recently: “The company is massively undervalued … the share price today is at an all-time high, but it could be significantly higher from where it is today.”
I totally agree with his assessment.
One reason for this is the huge valuation gap between U.S. oil companies and European oil companies. Take a look at free cash flow yield. On that metric, Shell trades above 12% and BP is at nearly 16%. Meanwhile, Exxon trades just under 7%, while Chevron is at 6.5%. Keep in mind that the higher the yield, the lower the stock’s valuation.
In addition, Shell has been working to boost profitability by selling less productive assets and cutting capital spending and operating costs. As the company moves past its period of heavy capex spending and continues to lower its cost structure, its free cash flow should improve significantly. This will provide additional fuel for dividend increases and share buybacks. In February, the company boosted its dividend by 4% and initiated a new $3.5 billion share repurchase program.
Relatively new Shell CEO, Wael Sawan, is sending the right message — that returns will take priority over growth — as he seeks to close that valuation gap.
Shell stands to benefit from the rise in global gas demand and likely strong prices over the next decade as LNG becomes integral to the energy transition. Shell will have an addition of 11 million tons per year of LNG production by 2030, which will lift LNG volumes over 25% by 2030.
SHEL stock is a buy at its current price of $72.
