You have 2 free articles remaining. Subscribe
« Back to Articles
Jan 27, 2025

Insights From ETFs - Energy: One Of The Cheapest Sectors In The Market At The Beginning Of 2025

by Michael Huynh

2024 was a strong year for the U.S. equities market in general, given the tailwinds from declining inflation and a new cycle of easing interest rates.

That being said, not all sectors performed. The Energy sector overall was up slightly, around 2% (dividend included) for the year, while the S&P 500 and Nasdaq have provided returns of approximately 25% and 32%, respectively. The drastic underperformance made energy relatively attractive compared to the overall market which is trading at premium valuations compared to historical averages.

The reasons for the underperformance

Coming into 2024, oil companies invested heavily to expand production capacity, given strong oil prices in both 2022 and 2023. These companies ramped up production either by increasing drilling investments or acquiring smaller energy companies.

However, the primary factor that affects the operating results for all oil companies is crude oil prices which have been anything but stable in recent months. The reasons for the significant volatility are due to unstable oil demand, driven by weak global economic activities, as well as geopolitical tensions in the Middle East.

However, amid global economic challenges, crude oil prices moved in the range of $70. Although most of the oil companies in North America were generating decent cash flow at these price levels, weak oil prices created a challenge for oil companies to grow earnings.

Consequently, amid a really strong year for the overall equity market, share prices of most oil holdings have been under tremendous pressure.

1. A low-risk cash cow with increasing capital returns

We think the energy sector is currently offering one of the most attractive risk/reward profiles for investors in years for a few reasons:

  • Thanks to the breakthroughs in oil drilling techniques, this innovation has allowed oil companies to access previously untapped reserves, helping them generate record cashflow with the same dollars of capital invested. 
  • Most oil companies are currently in great shape financially compared to previous cycles, due to much healthier financial disciplines, making them more resilient than ever in a cyclical downturn.
  • Due to the environmental, social and governance (ESG) trend and political pressure, oil companies are not incentivized to invest more in drilling. In addition, some of the fund’s mandate is not to own oil companies’ shares because of those ESG principles. Consequently, the value of these oil companies has dropped precipitously and become dirt cheap in terms of valuation multiples compared to the previous cycle, making it enticing for these companies to increase dividends and buybacks rather than invest in operation.

For these reasons, we remain optimistic about a favourable outcome for the energy sector over time. Moreover, with a cyclical sector like oil, investors should be prepared to act with a contrarian mindset. Reversion to the mean will happen sooner or later, and investors should maintain a healthy independence to capitalize on the recently attractive opportunities.

By applying a basket approach to the sector, investors are well-positioned between upside potential and downside protection. We think the current setup in oil prices could be great for another cyclical upturn, which could offer attractive prospective returns within the next three to five-year timeframe through a solid combination of dividend yield and capital appreciation.

Here are a few low-cost, diversified Exchange-Traded Funds (ETFs) that investors could look at including:

iShares S&P/TSX Capped Energy Index ETF (XEG)

The iShares S&P/TSX Capped Energy Index ETF (XEG)ís investment objective is to provide investors exposure to the Canadian energy sector. XEG is a well-established ETF which currently has $1.7 billion in Assets Under Management (AUM) and a Management Expense Ratio (MER) of 0.60%.

XEG’s portfolio is broadly diversified across the Canadian energy landscape. Some of the largest positions include Canadian Natural Resources (CNQ), Suncor Energy (SU), Cenovus Energy (CVE), Tourmaline Oil (TOU) and Arc Resources (ARX). These companies are solid businesses that have been in operation for decades, they are trading at record-low multiples while generating tremendous amounts of free cashflow that are ready to be returned to shareholders.

The overall portfolio is trading at a very attractive valuation, on average, XEG’s portfolio is trading at 9.9 times and 1.6 times in terms of Price/Earnings and Price/Book, respectively. The ETF also offers a decent twelve-month trailing yield of 3.4%, which is distributed quarterly.

Invesco Energy Exploration & Production ETF (PXE)

The Invesco Energy Exploration & Production ETF (PXE) is a U.S.-focused ETF that invest in companies that are engaged in the exploration, extraction and production of crude oil and natural gas from land-based or offshore wells. These companies are positioned across the value chain of the crude oil industry from refineries to finished products.

PXE currently has around $98 million in AUM, charges an MER of 0.63% and a twelve-month trailing yield of 2.84 %. PXE has an average P/E of 10.6 times and the Return on Equity on average, of 18.3%; the investees vary from small to large-cap with several holdings of 32 companies. The ETF’s prominent holdings include Occidental Petroleum (OXY), ConocoPhillips (COP), Coterra Energy (CTRA), EOG Resources (OEG) and Marathon Petroleum (MPC).

Energy Select Sector SPDR Fund (XLE)

The Energy Select Sector SPDR Fund (XLE) is an ETF that invests in large oil and natural gas producers through a concentrated portfolio. XLE’s top five largest positions account for more than half of the portfolio, including well-established companies like Exxon Mobil (XOM - 23.4%), Chevron (CVX ñ 15.6%), ConocoPhillips (COP ñ 7.6%), Schlumberger (SLB ñ 4.5%), and EOG Resources (EOF ñ 4.5%).

XLE has amassed a total AUM of around $33.2 billion, charges a tiny MER of 0.06%, provides an average dividend yield of 3.2% and a Price/Earnings ratio of 12 times. The fund’s median market cap is around $45 billion.