Why I’m wading back into energy stocks

By Covestor

The recent collapse in energy stocks is staggering.

It is every bit as damaging to the energy sector as the dot.com meltdown was to technology sector or the 2008-2009 disaster was to the financial sector.

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According to Bespoke Investment Group, as a percentage of S&P 500 weighting, the tech sector lost 63% of its peak to trough index weighting as the dot.coms collapsed.

The S&P weighting of financials declined 62% during the 2008 debacle and so far the energy sector weighting has fallen almost 60%, from its peak.

Wading In

Looking back long term investors wishing to buy low and sell high did well buying selected technology and financial stocks during those meltdowns.

Although it may be early, the Capital Ideas Macro Plus portfolio has jumped back into the fray.

We’ve purchased the SPDR Energy ETF (XLE), Kinder Morgan Inc. (KMI), and the MPLX LP ((MPLX)).

Investment Thesis

Although the overall theme of these purchases was exposure to the energy sector, each security had its own set of circumstances influencing our decision.

XLE was the most simple investment decision we could make. Because this account is tax deferred, it is possible to trade short term without taxable consequence.

Therefore we sold a position acquired earlier in XLE reducing short term exposure to the energy market.

With the ensuing collapse in oil prices we decided to buy it back. XLE holds various high quality securities within the energy sector and is our proxy for energy.

We may continue to trade the position stepping up size as prices decline.

Marathon Spinoff

MPLX LP is the product of a Marathon Oil pipeline spinoff.

Its recent acquisition of MarkWest Energy Partners exposed the company to the M&A arbitrage desks and in our opinion caused an extended decline in the price of MPLX.

We believe the decline is overdone and the security represents a good opportunity for both long term investors and short term traders.

If the addition of MarkWest’s Marcellus pipelines is accretive to the overall Marathon operation, this may yet be a growth opportunity in the MLP universe.

Bad Press

The last position we added may be the most controversial. Kinder Morgan has a very leveraged balance sheet.

It also has a large short position and is the subject of several negative articles in Barron’s magazine.

We have added a small position in the hopes that the company cuts its payout.

This would strengthen the balance sheet and allow the company a cheap source of capital for continued expansion.

We hope KMI cuts the payout all the way to $0.50 annually per share.  At the current price the yield would still be in excess of three percent.

Tax Edge

This is acceptable as KMI is now a corporation, not an MLP.

Therefore the dividend is qualified for favorable tax treatment and need not be as high as the typical MLP pipeline company.

This should help support the new value orientated shareholder group that is currently buying the stock.

With a payout of approximately 60% of GAAP earnings we believe KMI could be viewed as the growth utility it is.

The stock at current prices is controversial but offers a chance for reasonable short and long term gains, in our opinion.

Long Slog

We do not believe the energy sector will turn around overnight.  Neither technology nor financials did so after they collapsed.

However we do think the conditions necessary for a short term bounce are at hand. Relief from tax loss selling will come with the end of the month.

We cannot predict the price of oil, but we do feel it is very oversold and given a choice would rather be long than short over the next few weeks.

Photo credit: Anthony via Flickr Creative Commons

The investments discussed are held in client accounts as of December 15, 2015. These investments may or may not be currently held in client accounts.The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or that investment decisions we make in the future will be profitable.

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