I’m a fan of the energy sector. Aside from the very real possibility that China has economically bottomed, which would have all kinds of implications on energy demand, the sector broadly has been such a laggard over the past year and a half that I think it’s due for leadership. And if you agree, you may want to consider the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP). XOP has been around since 2006, and seeks to track the S&P Oil & Gas & Exploration Production Select Industry Index. The approach follows an equal-weighted strategy – something I believe is critical in the years ahead to consider for funds, whether specific like this or for broad market exposure.
A Look At The Holdings
I noted the equal weighting approach of XOP earlier. We can see that no position makes up more than 3.2% of the fund currently, with a total of 54 holdings. What is remarkable about the holdings is that they result in the total fund having a Price/Earnings ratio of just 8.76, with a Price/Cash Flow of 4.56. This is remarkably cheap, and it’s only a matter of time until the market rewards these stocks with higher multiples.
What do these companies do? Matador Resources Company is an independent energy company engaged in the exploration, development, production and acquisition of oil and natural gas resources in the United States, with an emphasis on oil and natural gas shale and other unconventional plays. APA Corp is an independent energy company engaged in the exploration, development, production, and acquisition of oil and natural gas resources in the United States, Egypt’s Western Desert, and the United Kingdom’s North Sea. Diamondback Energy, Inc. is an independent oil and natural gas company headquartered in Midland, Texas, focused on the acquisition, development, exploration, and exploitation of unconventional, onshore oil and natural gas reserves primarily in the Permian Basin in West Texas. EOG Resources, Inc. is engaged in the exploration, development, production, and acquisition of hydrocarbons. And Civitas Resources, Inc. is an independent energy company engaged in the exploration, development, and production of oil and natural gas resources, primarily focused on operations in the Denver-Julesburg and Permian basins.
All a nice mix for what the fund is trying to accomplish.
Sector Composition and Weightings
As to breakdown, exploration and production makes up nearly 75% of the fund, followed by refining and the integrated grouping.
To the extent that we see more demand for exploration with oil prices sticky, these companies should benefit overall, making the growth potential very real for an unloved part of the marketplace.
Peer Comparison
One fund worth comparing XOP against is the iShares U.S. Oil & Gas Exploration (IEO). This fund tracks the Dow Jones U.S. Select Oil Exploration & Production Index, contains 46 holdings, and which is NOT equal weight (ConocoPhillips and EOG alone make up 30% of IEO’s assets). When we look at the price ratio of XOP to IEO, we find that XOP unsurprisingly has underperformed in this large-cap only momentum-driven cycle. I expect this to change meaningfully though, so I’d prefer XOP on a go-forward basis over IEO.
Pros and Cons
On the plus side, the fund offers targeted industry exposure to the oil and gas exploration and production segment. This makes it ideal for investors who hope to bank on the cyclical nature of energy stocks. The equal-weighted methodology that seeks to limit concentration risks within the portfolio and make it more evenly weighted across market capitalization is a huge plus in my eyes, and one that makes this particularly appealing to me.
The downside? The energy sector broadly can be fickle due to commodity prices, geopolitical relations, and shifts in supply/demand. In addition, the narrow focus on exploration and production, which yes is bullish in my view, may result in more volatility than just broad-based exposure to all aspects of the energy sector overall.
Conclusion
Investors seeking to target their investments specifically to the oil and gas exploration and production segment should keep XOP on their radar. The valuation is cheap, the weighting methodology is robust, and the long-term outlet for a pickup in demand for exploration all makes this a unique part of the marketplace that can play catch-up from a momentum perspective to high-flying AI names. I think this is a good fund and worth considering overall.
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