I have been struggling for some time to get into a new stock in this sector for at least six months. I have had reasonable holdings of Woodside Petroleum (WPL) and Santos (STO) for many years but, as I wrote in my last column [1], I am thinking of increasing my energy exposure. Since I like to diversify when reasonable, I have been watching Oil Search (OSH) closely and I have not yet ruled out Origin Energy (ORG), in preference to topping up Santos and Woodside.
Is big better?
The two reasons for considering Oil Search and Origin over others in the sector, are that they have big enough market capitalisations for inclusion in my super fund and they have quite good consensus ratings (Table 1). Please see my website www.woodhall.com.au [2] (under the ‘Market Updates’ tab) for how I calculate consensus ratings.
Table 1: Data on companies in the ASX 200’s Energy sector
The energy sector only returned 2.8% since my last six-monthly review, against a market gain of 7.9%. All four of my stocks under consideration beat the sector return and no other large cap stock did. Of course, a lot is going on this week, as Iran has negotiated a deal with six western countries over its nuclear programme. That both the Presidents of Iran and the USA claimed victory from the talks last Sunday, suggests not much has really changed. The first round effect on oil prices was down – as were the stock prices for Oil Search, Origin, Santos and Woodside – on Monday, but there was a little bounce back on Tuesday. It would be worth keeping an eye on broker recommendations and share prices over the next few days – just in case a story develops.
The future is now
My sector statistics in Table 2 continue to show possible large capital gains in the energy sector – far more than in any other sector using my methodology. Indeed, my forecast gain of 29.6% over the next year is more than double the forecast gain of any other sector.
Although I have less faith in brokers’ target prices – in a sense a price forecast for 12 months out – than I do in the earnings and dividend forecasts I use in my sector forecast modelling – I have nevertheless analysed the target data to help form my current view.
I found a large discrepancy in the energy sector between these two approaches to valuing stocks/sectors that I need to rationalise. Thomson-Reuters supply the lowest, highest and median price target for each stock over a number of brokers (usually between 10 and 20 for large cap stocks). The median should be a reasonable representation of broker views, as there are usually five or so brokers on each side.
Table 2: ASX 200 sector statistics
The four options
I have plotted stock prices for the four stocks in Charts 1 – 4, making sure that the target prices have been shifted to show them as forecasts in 12 months time, rather than a valuation for today. That is, we only have price data to November 2013 but targets to November 2014.
Starting with Oil Search in Chart 1, the track record over 2013 is fairly impressive. The share price rose from around $7 to about $8.50 and the median target led that trend. What is unimpressive is that the target price flattens out from here to end at about $9. Importantly, the target price has fallen a little in recent weeks. I think I am going to have to see a $7 figure in the price to get me excited enough to buy. And not only do we have the Iran talks to consider but also PNG, as Oil Search comes up against a debt hurdle next March in that country. So if I buy soon, I might think of taking any profits off the table in a few months. Not really SMSF fare, unless the brokers start to up the targets to match my interpretation of their earnings and dividends forecasts!
Chart 1: Oil Search (OSH)
Note: the Thomson Reuters Datastream data are current to the close of business 25 November 2013.
The Origin Chart 2 does not make sense to me. The target prices have been falling, while the stock price was level and then climbing. The median target price has stabilised but it is only around current levels. That is less than exciting. Clearly, the brokers were not on top of this company.
Chart 2: Origin Energy (ORG)
Note: the Thomson Reuters Datastream data are current to the close of business 25 November 2013.The Santos data in Chart 3 is a little like that for Origin, but at least the target price is reasonably above the current price. Importantly, the range between the low and high targets has narrowed substantially in recent times. I am happy to remain invested in Santos.
Chart 3: Santos (STO)
Note: the Thomson Reuters Datastream data are current to the close of business 25 November 2013.Finally, Woodside in Chart 4 – the biggest company in the sector – has such a large target range, until recently, as to be close to meaningless. If I accept these data, there is little upside to the share price, but there is also little downside. To me, this is a wait-and-watch stock.
Chart 4: Woodside Petroleum (WPL)
Note: the Thomson Reuters Datastream data are current to the close of business 25 November 2013.My favourites
And now to my anomaly resolution! As an academic, I researched into forecasting behaviour. I found that forecasters often disguise their forecasts for a number of reasons. In particular, I found that forecasters behave differently when the forecast can readily be compared to the outcome. For example, many interest rate forecasters ‘follow the herd’ when publishing their 90 day and 10 year rates but do not herd when (implicitly) forecasting the difference (yield) between the two. On these grounds, I conjecture that target prices are less useful than earnings and dividends because there might be a tendency not to stray too far from the current price when deciding on a target. While I have never attempted to test this conjecture, my professional observations over the last 30 years are enough for me to accept the hypothesis to my satisfaction.
So my interpretation of these target price charts is that Santos is the stand out. And with the sector cheap (5.4% from Table 1), there could be an opportunity to top up soon. Oil Search is on the back burner and Woodside is a hold – at least for me. So I am looking to top up Santos at a good price – even current prices – but carefully watch Woodside (to possibly sell) and Oil Search (to possibly buy). And if it takes a month or two to arrive at my decision – so be it.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report:
- Maureen Jordan: Why we are rebalancing the Switzer family SMSF [3]
- Charlie Aitken: It’s all about the cyclicals – JBH, WOW and a Dick Smith float [4]
- Penny Pryor: Message to SMSFs – we love you just the way you are [5]
- Penny Pryor: Buy, Sell, Hold – what the brokers say [6]
- Tony Negline: How to supplement your income with Centrelink benefits [7]
- Questions: Time to look outside the big stocks [8]