The iShares Global Energy ETF (NYSEARCA:IXC) invests in a basket of the largest and most important oil and gas producing companies in the world. This is a sector that has been particularly impacted by the ongoing COVID-19 pandemic which led to a crash in oil prices earlier this year. Indeed, the fund is down over 45% year to date and remains pressured facing uncertainties related to the strength of the economic recovery. That being said, we think IXC deserves a second look with compelling value and an attractive dividend yield of over 6%. We like the fund’s exposure to global energy leaders that are well-positioned to not only survive the current challenges but also offer significant upside potential. We think the recent volatility presents a buying opportunity in what is a quality fund worthy of a long-term allocation as a core-holding.
The IXC fund with approximately $650 million in total assets under management is a passive exchange-traded fund that tracks the performance of the ‘S&P Global 1200 Energy Sector Index’. The fund uses a “representative sampling” methodology that is meant to capture the exposure of the index through a smaller selection comprising of at least 90% of the index by market cap. IXC currently holds 58 equities across large-, mid-, and small-cap companies based on a market-cap weighted methodology.
The investment strategy is global and includes a combination of U.S. based market leaders like Exxon Mobil Corp. (NYSE:XOM) and Chevron Corp. (NYSE:CVX) as the largest positions in the fund along with major companies from other countries. One of the strengths of the fund is that it provides exposure to energy stocks that are not widely held in alternative energy sector funds. France’s Total SE (NYSE:TOT), Brazil’s Petrobras SA (NYSE:PBR), and China’s CNOOC LTD (NYSE:CEO) highlight the fund’s global perspective.
We think it’s worth contrasting IXC with the Energy Select Sector SPDR ETF (NYSEARCA:XLE) which tracks the performance of the sector stocks that are included in the S&P 500 Index (SPY). In our view, IXC which includes foreign energy companies is simply a better way to gain diversified exposure to the sector trends through a more diversified portfolio of large-cap energy names.
For reference, compared to the 58 holdings in IXC, the XLE ETF is more concentrated with only 29 stocks, and the top 10 positions represent 79% of the fund against 58% for IXC. While XOM and CVX are the top 2 investments in both funds, the combined 46% weighting of both in XLE is nearly double the allocation in IXC, and unnecessarily too high. Without picking individual winners and losers, mega-cap energy companies like Total SE, Enbridge Inc. (ENB), BP Plc (BP), and Royal Dutch Shell Plc (RDS.A)(RDS.B) included in IXC are well-positioned to not only survive the current environment but trade significantly higher on a future recovery in the sector.
(Source: Seeking Alpha)
Year to date, IXC is down 45% with widespread declines among the major holdings. The foreign stocks in the fund have separately been pressured given a stronger U.S. dollar. Among the top-10 holdings, Royal Dutch Shell is down by 58% year to date as the worst performer while TC Energy Corp. (NYSE:TRP) has outperformed the sector with a narrower 15.6% decline.
Looking back at the performance history of IXC, it has been a disappointing last decade for energy investors with the fund down a cumulative 33% over the past 10 years. The context here is the crash in the price of oil over the period, considering Brent Crude traded above $120 per barrel in 2012 and is now down more than 60% over the period.
Globally, the oil industry was defined by a surge of production and new supply coming online which outpaced the demand growth over the past decade. Many oil companies were overleveraged and found themselves on the wrong side of the market positioned too aggressively for higher prices leading to weak earnings and an overall contraction in the sector in recent years. This year’s pandemic was another setback forcing a reset of expectations.
Favorably, we highlight that the IXC ETF down 39% over the past 5 years through October 19th has been able to outperform the XLE ETF down a 46% over the same period. The point here is that we believe the wider diversification has helped support the return profile on a risk-adjusted basis and makes it a stronger fund going forward.
IXC pays a semi-annual dividend which is consistent with the distribution policies of several foreign energy companies that pay out twice a year. Currently, the fund’s yield on a trailing-twelve-month basis is 11.4%, although this includes a portion related to the income received from the mega-acquisition of Anadarko Petroleum Corp. by Occidental Petroleum (NYSE:OXY) last year classified as a non-recurring special dividend in December 2019 payout. Excluding this amount, the current yield is approximately 6.6%.
Yields in the energy sector are a tricky subject this year. Many companies cut their payouts to preserve cash in the lower earnings environment. IXC holding Royal Dutch Shell was a notable example announcing a cut to the quarterly payout to $0.32 per ADR from a previous $0.94 rate. Other stocks that have seen significant declines in their share price continue to face some uncertainty or speculation regarding the sustainability of their current payouts. Exxon Mobil Corp. stock yields 10.2%, and while the company has not announced any changes to its dividend, the high yield suggests the market remains skeptical it can be maintained.
We are of a more optimistic view and think the major dividend cuts have already been announced and believe current payouts are now supported by an improving outlook. Nevertheless, the result here is that it’s unclear what a true forward yield for the IXC ETF is. We estimate the yield will remain over 6% at the current share price, which is compelling relative to the broader market.
Analysis and Forward-Looking Commentary
The first step in turning bullish on the energy sector and the IXC fund is to look past the historical performance data and recent weakness. What’s important is going to be the forward outlook and the opportunity to pick up shares following a reset of expectations at a lower share price. We think there is value here in an area of the market that has been beaten down but can still recover with a significant upside from the current level.
It’s encouraging that the price of Brent crude oil as the global benchmark has been relatively resilient in recent months and continues to trade above $40.00 per barrel. There is a delicate balancing act between still tepid demand against a material pullback of supplies as the most marginal drillers took capacity offline in the low pricing environment this year.
According to forecasts by the U.S. Energy Information Association “EIA”, total world petroleum production is set to fall by about 6.1% this year compared to an 8.5% decrease in total global consumption. For 2021, the group sees a faster rebound for consumption which could climb by 6.7% compared to a 4.5% uptick in production.
(Source: EIA/annotation by BOOX Research)
The demand recovery would be driven by an improvement in mobility and air travel with an expectation that the coronavirus pandemic gets under control. The setup here implies fundamental support for the price of oil which is a positive trend for underlying constituents of the IXC ETF.
Overall, we rate IXC as a buy and see the fund as providing a good combination of yield and upside potential. The ability of the cash flow environment to improve for the major players and a stabilizing outlook could support more positive sentiment towards the group.
In terms of risks, beyond a complete deteriorating to the global macro conditions, the price of oil remains a monitoring point. We’re watching the $40.00 per barrel level in the price of Brent Crude as an important technical level we expect the market to hold. The next support level going down to $30.00 would require a more serious collapse of global conditions. IXC investors should follow the upcoming Q3 earnings reports for the energy sector to gauge cash flow trends and industry guidance from company management teams.
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Disclosure: I am/we are long IXC. 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.