zhengzaishuru Fund Overview The SPDR S&P Oil & Gas Equipment & Services ETF (NYSEARCA:XES) offers investors a focused opportunity to gain exposure to the oil and gas services sector. Launched in 2006, XES is designed to track the S&P Oil & Gas Equipment & Services Select Industry Index, which comprises companies from two key sub-industries: Oil & Gas Drilling, and Oil & Gas Equipment & Services. The fund’s primary objective is to provide investment results that generally correspond to the total return performance of this index. XES has a few standout features: it employs a modified equal-weighted index approach, potentially offering more balanced exposure across large, mid, and small-cap stocks compared to market-cap weighted alternatives. This strategy aims to reduce concentration risk and provide more diversified industry exposure. With an expense ratio of 0.35%, XES positions itself as the most cost-effective option among its peers (IEZ, PXJ, CRAK, PXE, and IEO) which is a positive for long-term investors. The fund currently holds 33 stocks, with its assets spread across the Oil & Gas Equipment & Services (72.90%) and Oil & Gas Drilling (27.10%) sub-sectors, closely aligning with its benchmark index. Seeking Alpha In terms of dividend performance, XES lags behind similar ETFs. With a trailing twelve-month (TTM) dividend yield of 0.89%, XES offers the lowest yield among the compared funds where yields range from 1.42% (iShares U.S. Oil Equipment & Services ETF, IEZ) to as high as 3.53% (VanEck Oil Refiners ETF, CRAK). The dividend growth picture for XES is equally concerning, showing negative growth rates of -4.69% over 3 years and -3.14% over 5 years (CAGR). This downward trend in dividend growth sets XES apart from its peers. iShares U.S. Oil & Gas Exploration & Production ETF (IEO) boasts a strong 31.90% 3-year dividend growth rate, while Invesco Energy Exploration & Production ETF (PXE) shows a strong 29.72% growth over the same period. Even when compared to IEZ, which also shows negative 5-year growth (-4.64%), XES still underperforms. In terms of consistency, XES has maintained only 1 year of consecutive dividend growth, matching IEZ but falling short of PXJ, CRAK, and PXE, each with 2 years of consistent growth. If you’re looking for steady income, XES’s weak dividend performance might not be your best bet. Because of that, the focus for XES as an investment will be on price growth. XES’s liquidity and concentration is solid when compared to its peer ETFs. With an average daily volume of $7.16 million, second only to IEO, XES will present no liquidity issues to investors. Additionally, the fund stands out for its lower concentration risk, with only 46.83% of assets in its top 10 holdings, which is at the bottom of the range for the identified peer funds. However, investors should note its higher volatility, indicated by a 5-year beta of 1.79. This combination of strong liquidity, lower concentration, and higher beta means that XES is a solid option for investors that want diversified and dynamic exposure to the oil and gas equipment and services sector. Oil & Gas Market Dynamics Oil and gas dynamics suggest that even though production is at all-time highs, firms are being cautious about further output expansion. Since the pandemic has ended, U.S. crude oil production grew steadily to the current all-time highs. Refinery inputs and utilization rates are at post-pandemic highs and geared up for the busier summer season. Despite that, there are signs of a slowdown in drilling activity are evident in Baker Hughes’ rig count data. US oil and gas rig counts have been falling steadily since their peak in late 2022, reaching the lowest levels since December 2021. In terms of supply and demand, oil and gas inventories and products supplied are keeping pace with previous years, but there is a bit of a rise in US days supply of crude oil inputs and finished gasoline stocks. Baker Hughes, EIA, Dallas Fed In terms of investment from upstream firms, that has slowed notably in the last two years. The Dallas Fed Energy Survey indicates that Exploration & Production (E&P) capital expenditure has flattened in recent quarters, while the Services Business Activity has also plateaued and Operating Margins have decreased. On the pricing front, the bloodbath appears to be over. Natural gas prices have shown some recovery from their 2024 lows, and crude oil prices have rebounded from a weak second quarter. Both of these price trends are supportive of upstream investment growth in the future. However, for now, oil and gas service companies are facing some headwinds due to declining counts and flattening exploration and production capital expenditures. Valuation Ratio June 2020 June 2021 June 2022 June 2023 June 2024 P/E Ratio 49.7x 29.1x 19.6x 9.8x 15.2x P/B Ratio 0.4x 1.0x 1.3x 1.6x 1.7x Click to enlarge The valuation of oil and gas services firms has normalized since the end of the pandemic as XES’s constituents have experienced significant growth in recent years, with a 3-5 year EPS growth of 29.1% as the market recovered from pandemic-related low energy prices and recent inflation. Because of that, the P/E ratio for XES fell from 49.7x in June 2020 to 15.2x in June 2024 as revenues recovered when production and rig counts jumped in 2022 and 2023. This brought the fund more in-line with the broader market. Compared to the S&P 500 valuation, represented by SPY’s P/E ratio of 24.7x, XES appears to have a fairer valuation. When compared to the energy sector more specifically, as represented by XLE’s P/E ratio of 13.5x (which is slightly below the 5-year mean for the general energy sector), oil and gas services firms within XES are mostly in-line with sector valuations. This suggests that XES firms are currently valued appropriately relative to both the broader market and their specific sector. Data by YCharts XES’s 1-year total return has normalized to around 15.97% as of July 2024, following a period of significant volatility and recovery from post-pandemic lows, and represents a more stable and sustainable growth rate. The stabilization of returns could be a signal of a reduction in the risk premium associated with oil and gas equipment and services stocks which should help the valuation thesis as investors can be more confident that the XES will settle into more stable growth. Opportunities for Investment Growth Higher valuations only make sense if investors see future earnings growth. The good news is that even though the oil and gas market dynamics are tepid, opportunities for growth in the oil and gas sector are improving. These opportunities will be encouraged by falling interest rates, as central banks are likely to enter their rate cutting cycles at the end of 2024 and beginning of 2025. In response to easing financial conditions, major oil and gas projects will be easier to finance and, thus, there will be an increase in the demand for services. We are already seeing governments, looking to secure their countries’ energy futures, intend to increase investment. Most recently, we have seen Saudi Arabia’s Aramco award $25 billion in contracts that will add gas rigs, wells, pipelines, and trains with the hope of increasing natural gas sales by 60% by 2030. In Argentina, President Milei’s government has approved tax incentives that will help to incentivize investment into energy infrastructure that could include the construction of an LNG export terminal. The increase in traditional oil and gas investment is also likely to be correlated with the rise of more right-wing politicians, especially in the US and Europe, where energy policy has been trending away from fossil fuel sources. In the US specifically, a Trump presidency could be supportive of investment in many ways, including reversing Biden’s pause on LNG export project approvals for non-FTA countries, increasing offshore lease sales in the Gulf of Mexico, and revoking tax credit regimes for renewable energy components introduced by the Inflation Reduction Act (IRA). Based on PredictIt betting markets, a Trump presidential election win is hovering around 60% with about four months to go until the polls open. Recommendation Given the current market dynamics and valuation metrics, I’m issuing a Hold rating for XES. The fund’s fair valuation relative to the broader market and energy sector, combined with the recent normalization of oil and gas services firms’ P/E ratios, suggests a balanced risk-reward profile at present, but current market conditions are a headwind. However, this Hold rating could potentially upgrade to a Buy as the likelihood of a Trump presidency increases. Trump’s proposed policies could significantly boost investment in the oil and gas sector in the US, which would add to the slowly growing desire for more oil and gas investment abroad. Additionally, the anticipated easing of financial conditions and increased global investment in energy infrastructure present promising growth opportunities for the sector. I will continue to monitor these developments, a possible shift to a more favorable Buy rating in the next 6 months.
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