After a big run for energy stock this year, a slide in oil prices following news that OPEC agreed to boost production has helped take the steam out of the sector's rally.
Despite the pullback, most energy names are still trading either in overvalued territory or at prices that are in line with Morningstar's estimates of fair value, meaning that prospects for additional long-term gains could be hard to come by.
But we screened the energy sector in search of any stocks that may have fallen back to levels that Morningstar analysts peg as cheap. We found four: Pioneer Natural Resources (PXD), Plains All American Pipeline (PAA), Eni (E), and Holly Frontier (HFC).
"The sector was unloved before the recent runup in prices inflated stocks temporarily," says David Meats, Morningstar energy equity research director. "So, stocks like Pioneer Natural Resources were fairly valued but only because the market was simultaneously 1) overweighting high near-term prices and 2) unfairly discounting the long-term value generation. The OPEC deal has eliminated the first of these issues but not the latter, hence certain stocks are now looking cheap."
This landscape reflects a significant change of fortune for the sector, as most energy stocks were trading at bargain-level prices at the start of 2021 after years of low and falling oil prices.
Here's a look at the Morningstar Ratings for the 58 energy stocks covered by Morningstar analysts. Stocks with 4 or 5 stars are undervalued, and 1- or 2-star stocks are overvalued. Stocks with a 3-star rating are considered fairly valued.
In July 2020, 43% of energy stocks covered by Morningstar were in 5-star territory; that percentage now stands 3%. The 4-star stock bucket also shrank significantly, falling to 26% from 47%. Meanwhile, 3-star stocks now make up 54% of our energy coverage list.
The backdrop for the sector is the recent slide in oil prices. Heading into July, oil prices had rallied 82.4% over the past year--with a 55.1% increase through July 13--as a pickup in demand collided with the depressed levels of production that resulted from the pandemic. Oil prices have been volatile after topping $75 per barrel on July 1 for the first time since 2014. Just this week, the WTI benchmark has fallen 4.3% to nearly $72.
As oil has fallen, the sector has broadly traded lower, as can be seen with Energy Select Sector SPDR ETF (XLE). The $23.7 billion exchange-traded fund is down 8.7% from its peak on June 15, 2021. But despite that decline, XLE is still up 50.4% from a year ago and 89.9% from its pandemic low set on Oct. 28, 2020, and it has outpaced the overall market as measured by the Morningstar US Market Index.
Despite the retreat in oil prices, many stocks are still trading at rich levels after big rallies.
Take Laredo Petroleum (LPI). The stock was trading at roughly 3 times its fair value estimate on July 1, 2021, hitting a 52-week high of $99.25. Its stock price has since fallen back to below $70, but that remains well above our fair value estimate of $33 per share.
But with the pullback in the sector, the roster of 4-star energy stocks has grown slightly. As of the close of trading on July 14, 18 of the 58 energy stocks fell into that undervalued category. Here are the four new entrants to that group:
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