dszc/E+ via Getty Images

dszc/E+ via Getty Images

I was quite bullish on energy plays after the complete bust in crude oil during March-April 2020. The drop from $70 to under $20 per barrel was caused by COVID-19 pandemic shutdowns in the global economy, at the same time as a vengeful decision by Saudi Arabia was made to flood the crude oil marketplace (an effort to drive Russia, OPEC overproducers, and rising Texas suppliers into a money losing position).

I wrote a number of positive articles on individual U.S. energy names throughout last year and most of this. About a year ago in November 2020 here, I wrote a note on the strong upside inherent in the iShares U.S. Oil & Gas Exploration & Production ETF (IEO). Of course, nobody read the effort (measured by total page views) when the oil market seemed like dead money. Nevertheless, buying an out-of-favor sector with solid values, net income still rolling in, and high dividend yields proved a wonderful investment proposition. As of today, this pick is up +154% over 54 weeks.

Boy have things changed! Fast forward to November 2021, and pretty much every advisor and investor is now wildly optimistic on the U.S. energy sector. The contrarian slant in me says now may be a great time to take profits or hold off on oil/gas investments until a serious correction of 15-25% appears in the sector. The oil/gas business can see production and demand upswings and downswings lasting a number of years. Arguing in favor of a long-term bull phase in energy make sense, for sure, as capital investment in new exploration and production has all but evaporated for a couple of years. Yet, investor sentiment on the sector can also be incredibly cyclical inside a multi-year advance. So, volatile countertrend moves happen once or twice each year. My take is we are getting overdue for a breather in energy shares.

Specifically, if you own or are thinking of buying the Energy Select Sector SPDR ETF (NYSEARCA:XLE ), or other creations like it, waiting for a better entry point makes a lot of sense. This financial product represents diversified blue-chip exposure to the U.S. energy sector and oil/gas stocks. For investors looking for a stable and conservative, high-dividend payout choice in energy names, using a one-decision, one-trade weighting ETF, I suggest XLE over comparable peers available.

The ETF expenses a super-low 0.12% in management fees per annum, while it paid a 3.7% trailing annual dividend yield on today’s $57 quote. Below is a listing of the Top 10 holdings as of the end of October 2021. The Energy SPDR is heavily concentrated in the remaining Standard Oil choices of Exxon Mobil (XOM) and Chevron (CVX), with U.S. E&P, oilfield service, product refinery and pipeline companies rounding out the vast majority of positions. Included with high weightings are Schlumberger (SLB), EOG Resources (EOG), ConocoPhillips (COP), Pioneer Natural Resources (PXD), Marathon Petroleum (MRO), Williams (WMB), Phillips 66 (PSX), and Kinder Morgan (KMI).

Measured against the S&P 500, big energy names have roughly doubled the total performance of the average U.S. blue chip the past 12 months. Below is a chart of the Top 10 for total investor gains, including dividends, with the XLE and SPDR S&P 500 ETF (SPY) drawn for comparison.

The really good news for income-oriented investors is petroleum-related dividends remain a top attraction vs. other industries and sectors on Wall Street. The dividend yields below are based on stock price changes and cash distributions adjustments made the last three months by each company.

Even better news for investors, oil/gas companies are trying to repay debt and avoid massive CAPEX projects until commodity prices stabilize for a year or two. Free cash flow from the industry is now running at a record high, and is honestly about DOUBLE the rate being generated by other S&P 500 businesses as group.

In addition, price to forward 1-year estimated sales ratios are well below the current S&P 500 expectation of 3x in November 2021. Due to the cyclical nature of the business, with low net profit margins, oil/gas companies usually trade at a discount on this basic valuation multiple. I rate the sector as fairly-valued on price to sales calculations, relative to the general market.

Lastly, enterprise value to trailing EBITDA is still recovering from the crude oil bust of 2020. If fossil fuel prices remain about where they trade today, this ratio should improve across the board. Compared to a 12x multiple for the S&P 500 in 2018, pre-pandemic, the main U.S. blue-chip index sells for a whopping 20x EV to EBITDA reading in late 2021. So, numbers around 13x for the energy sector seem to be on the fair to low side of the ledger (assuming a significant oil/gas price decline is not our future).

I have graphed crude oil and natural gas quotes below, using nearest futures trading in New York. Looking at daily price and volume action over 30 months, it’s safe to say the record money printing effort by the Federal Reserve since early 2020 has been extremely successful in propping up energy prices.

For XLE specifically, its quote has recovered close to 2019’s high trade level. Momentum indicators remain bullish, although many of the ones I track have downshifted dramatically since March. Again, my view is a 10-15% S&P 500 correction from rising interest rates will also ding energy names.

I have drawn a box in green below, as my target zone for new buyers to accumulate XLE on any rapid drop underneath its 200-day moving average, now around $50. A slide to $43 to $49 (depending on how severe the Wall Street correction overall becomes) should scare away the hot money crowd in energy names, and provide a smarter base to compound your money.

Riding an upswing to $65 next year will be much more profitable, when buying at $45 for example, than $57 today. The difference will be a 50% total return on your investment vs. less than 20% achieved by jumping on XLE right now, if my patient and thoughtful approach becomes reality (I cannot guarantee energy names will decline anytime soon).

I have been expressing my concern about a general stock market correction dragging down energy and oil names for a spell, really for several months running, on chat boards and the comment sections of other SA articles. My view is a better risk/reward entry setup in the near future may reset the field for another decent year in energy investments during 2022. Wall Street does not move in straight lines, although the 2021 situation definitely feels like it, nearly across the U.S. equity spectrum.

Don’t get me wrong. I am still long-term bullish on energy prices, if only from my belief excessive money printing from central banks worldwide will continue next year. Falling consumer confidence and rising interest rates in America could bring a weaker economy over Christmas (the University of Michigan November Survey is at a level consistent with past recessions), cause stocks to fall into a needed correction, and possibly talk the Fed into less tapering on top of new money printing schemes for 2022.

Image Source: University of Michigan Consumer Survey

That’s my current battle plan for oil/gas names, in a nutshell. I am waiting for another bullish entry point. I sold my last oil name several weeks ago, and I will sit out for my anticipated correction in the U.S. equity market.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.

This article was written by

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am short SPY. This writing is for informational purposes only. All opinions expressed herein are not investment recommendations, and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity and is not a registered investment advisor. The author recommends investors consult a qualified investment advisor before making any trade. This article is not an investment research report, but an opinion written at a point in time. The author's opinions expressed herein address only a small cross-section of data related to an investment in securities mentioned. Any analysis presented is based on incomplete information, and is limited in scope and accuracy. The information and data in this article are obtained from sources believed to be reliable, but their accuracy and completeness are not guaranteed. Any and all opinions, estimates, and conclusions are based on the author's best judgment at the time of publication, and are subject to change without notice. Past performance is no guarantee of future returns.