The cheapest valuations in at least 14 years are making oil companies too alluring to pass up for UBS and Guggenheim Partners, though earnings in the industry may fall 48 percent this year.
Oil and gas producers in the MSCI World index traded at $7.84 (R63.48) a dollar of profit this month, less than half the average of $17.10 in the gauge of developed markets and the widest gap since at least 1995, Bloomberg data show.
UBS, Guggenheim and New York-based Cohen & Steers are buying stocks from Exxon Mobil to Transocean because an economic rebound will lift the industry after it generated at least 50 percent more profits than any other group in the past year.
Recovering energy shares may signal an end to the 42 percent drop in the MSCI World index since October 2007 and the first global contraction in six decades. Rallies in oil and gas stocks marked the end of the last five US recessions based on average returns, according to Ned Davis Research.
"Energy will be one of the industries that lead us out," said Scott Minerd, the chief investment officer at Guggenheim in California.
Plunging shares
"Shares are cheap and attractive. It's a very good time for investors to buy the group betting on stronger demand for commodities and a rebound in earnings," Minerd said.
The MSCI World index added 0.2 percent to 984.48 as of 6.53am in London, with a measure of energy shares in the index rising 0.3 percent.
Crude oil climbed above $64 a barrel in electronic trading on the New York Mercantile Exchange.
Minerd is boosting holdings even as analysts predict the global slump in energy demand will cause per-share earnings at energy companies in the MSCI World index to drop to $13.36 from $25.74 last year, share-adjusted data show.
Profits at Exxon Mobil and San Ramon, California-based Chevron, the two biggest US oil companies, and BP, the second-largest in Europe, will fall at least 50 percent, according to per-share estimates.
Exxon and Chevron reported record earnings last year, while BP's was within 6 percent of an all-time high.
Along with Royal Dutch Shell, they made up four of the five most profitable companies in developed countries during the past 12 months, data show.
Their shares are trading at the steepest discounts on record because investors are still shocked by the 78 percent plunge in crude prices.
While oil is up 43 percent this year, it fell as low as $32.40 a barrel in New York on December 19 from a record $147.27 a year ago.
The bargains
The Paris-based International Energy Agency estimates that the global recession will slash worldwide oil demand by 2.8 percent this year.
Lower profits have prompted the Hague-based Shell, the largest oil company in Europe by market value, to put two refineries in northern Germany up for sale, and it may close or sell another plant in Montreal.
Without increased demand, energy shares would not beat the stock market's performance, said E William Stone, the chief investment strategist at PNC Financial Services Group's wealth management unit in Philadelphia.
"Energy shares are not necessarily cheap, especially looking at the past 12 months of earnings," said Stone.
"You're looking at the rear-view mirror at much higher oil prices. That may mislead you."
Valuations for energy companies are 54 percent below the average for the MSCI World index, almost twice the gap of any other group, according to data.
On a per-share basis, energy companies generate almost 12c in profit for every shareholder dollar, the highest earnings yield among the 10 industries in the MSCI World index.
Exxon Mobil made $38.9 billion over the last four quarters and has never traded at a bigger discount to the world index's average, data show.
The second-largest company by market value fetches 9.35 times earnings, 49 percent less than the average for the benchmark of 23 nations.
Shares of Geneva-based Transocean, the world's largest offshore driller, are valued at 5.19 times profit, a 72 percent discount to the MSCI World index. That is close to the widest gap since at least 1995, the data show.
Those were bargains, said Mike Ryan, the New York-based head of wealth management research for the Americas at UBS Financial Services.
"Energy shares were at depressed levels," he said.
"As the economy gains some traction, commodity prices will recover and that will support the energy market and energy stocks."
UBS Financial, a part of Zurich-based UBS, had its biggest overweight position in energy stocks, compared with investments in each of the 10 industry groups in the Standard & Poor's 500 index, Ryan said.
John Praveen, the chief investment strategist at New Jersey-based Prudential International Investments Advisers, a unit of Prudential, said faster growth in emerging markets and a recovery in industrialised nations would increase demand, profits and stock prices.
The world economy will expand 2.5 percent next year after contracting 1.4 percent this year, according to an estimate by the International Monetary Fund on July 8.
Emerging and developing economies would grow 1.5 percent this year and 4.7 percent in 2010, the Washington-based lender said.
China, the world's third-largest economy, grew 7.9 percent in the second quarter, the government's statistics bureau said on July 16.
"We're overweight energy not just based on valuations, but also based on macro factors," Praveen said.
His company raised its allocation to energy shares last month to overweight from underweight and likes companies such as Houston-based Halliburton, the second-largest oilfield services provider.
Crude oil will average $85 a barrel next year, according to Morgan Stanley, which lifted its estimate by 31 percent last week. The New York-based bank's forecast is higher than the fuel has traded in any full year except last year, when it averaged $99.75, according to Bloomberg data.
Analysts have increased their 2010 profit estimates for the five largest energy companies in the MSCI World index from their April and May troughs, according to data.
The consensus forecast for Irving, Texas-based Exxon Mobil's 2010 adjusted earnings rose to $6.04 a share last week from a low of $5.64 in May.
Oil stocks increased for the first time in five weeks last week, jumping 8.4 percent for a gain of 5.6 percent this year. The MSCI World index has added 6.8 percent this year.
"We're looking out into next year," said Richard Helm, a Seattle-based portfolio manager at Cohen & Steers.
"Given the cash flow they generate and the earnings power that they have, shares are attractively priced here."
Helm bought Exxon stock last quarter and the company is now the biggest holding in his Cohen & Steers Dividend Value Fund.
History shows that energy companies lead the US stock market higher when economic growth resumes.
US oil and gas producers gained 12.6 percent on average in the six months following the end of the past five contractions since 1975, the most among S&P 500 groups, data compiled by Florida-based Ned Davis Research show.
During the five-year bull market that ended in October 2007, energy stocks posted a total return of 256 percent as oil increased by 222 percent. That outpaced the MSCI World index's 168 percent gain, including dividends.
'A big positive'
Dividends in the industry were the highest in five years versus the MSCI World index last month, with the average company paying 3.44 percent of its share price to stockholders, according to quarterly data.
The yield exceeds the average payout for the world index for the first time since December 2004.
"That's a big positive" that oil companies were able to maintain their dividends, said Thomas Deser, a Frankfurt-based fund manager at Union Investment, which owns BP, Total and Shell.
"At the moment, the oil price is lower than it should be. Demand should pick up once the global economy comes back."
Among non-financial companies in the 1 654 stock MSCI World index, two - Paris-based Total and Shell - have at least $15bn in reserves, are valued at less than 10 times earnings and pay at least 5 percent of their share value in dividends, according to data.
Total, Europe's third-largest oil company, trades for 9.3 times profit, about half the multiple of the MSCI World index, data show.
The company has a dividend yield of 5.91 percent.
The yield on London-traded Class A shares of Shell, Europe's largest supplier, increased to 6.56 percent.
Shell's payout is the highest compared with the MSCI World index since at least 2005, according to quarterly data.
"We're starting to build back up again," said Scott Richter at Fifth Third Asset Management in Cleveland.
"Now is the time to start positioning for the recovery." - Bloomberg