The oil and gas sector has been the worst-performing sector in the S&P 500 over the past decade. Oil and gas companies now account for just 4.4% of the S&P 500, while in 1980, they represented more than 28% of the index.
Between the beginning of September 2009 and September 2019, the energy sector yielded a total return of around 10%. The best-performing sectors, consumer discretionary and information technology, have produced a total return of more than 350% over the same period.
Volatile oil prices have buffeted oil companies since 2014, hitting sales hard. Meanwhile, rising costs have eroded profit margins. Further complicating matters are investors selling their fossil fuel stocks due to concerns about the environment.
There has been a sharp rise in the number of investors dumping fossil fuel stocks in 2019. A recent article in The Financial Tims noted that asset managers representing $11 trillion worth of investments have committed to shedding their fossil fuel holdings.
However, the sector's underperformance and low valuation compared to the rest of the market is starting to attract value investors. Indeed, some of the biggest names in value investing have started to buy oil and gas stocks over the past 12 months, taking advantage of the sector's discounted prices compared to the S&P 500. In 2011, the energy sector was trading at about the same level as the broader market on a book value multiple. It is now trading at 1.5 times book compared to 3.5 for the S&P 500.
The most notable investor who has made a substantial investment in the sector recently has been Warren Buffett (Trades, Portfolio). Earlier this year, Buffett's Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) committed to investing $10 billion in Occidental Petroleum (OXY, Financial), buying to help fund its proposed acquisition of Anadarko Petroleum.
The conglomerate committed to buy 100,000 shares of preferred stock, which pays out an 8% annual dividend. In addition to this position, Berkshire acquired around 7.5 million common shares in Occidental for its stock portfolio in the third quarter, according to the group's 13F filing with the Securities and Exchange Commission.
In an interview with CNBC soon after the deal was announced, Buffett said the investment was a bet on oil prices and a "bet on the fact that the Permian Basin is what it is cracked up to be."
Buffett isn't the only billionaire hedge fund manager buying the sector. Carl Icahn (Trades, Portfolio) acquired a 33.2 million common share position in Occidental during the second quarter. This was an activist position, but Ichan is a value investor at heart, and he will only invest in a stock if he thinks it is undervalued.
Lee Ainslie (Trades, Portfolio)'s Maverick Capital and Michael Price (Trades, Portfolio)'s MFP Investors also added Occidental in the third quarter. Maverick added a holding in Devon Energy Corp. (DVN, Financial) as well.
One small position that Klarman added to Baupost's $9 billion equity portfolio in the third quarter was Mexican oil and gas company Vista Oil & Gas SAB de CV (VIST, Financial). According to my calculations, this company is trading at an enterprise value to Ebitda ratio of 5, is planning to increase oil production at a compounded annual growth rate of 28% through 2022 and is reducing operating expenses to $10.50 from $17.30.
The Financial Times also reported that even distressed investor Sam Zell is buying energy holdings. He has reportedly been buying energy assets in California, Colorado and Texas at fire-sale prices. "The current environment in the oil sector creates opportunities where there is limited competition," he told the newspaper in an interview.
Kahn Brothers (Trades, Portfolio) Advisors, the group founded by value legend Irving Kahn, has been adding to its holdings in BP (BP, Financial), Patterson UTI-Energy (PTEN, Financial) and Exxon Mobil (XOM, Financial) this year. Howard Marks (Trades, Portfolio)' Oaktree Capital Management's largest distressed stock holding at the end of the third quarter was Vistra Energy Corp. (VST, Financial). The group increased its holdings in the stock by around 20% to more than 27 million shares in the second quarter.
Disclosure: The author owns shares of Berkshire Hathaway.
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