Will Buffett bet big on oil again in 2023?

For decades, Chairman and CEO of Berkshire Hathaway (NYSE:BRK.B), Warren Buffett, maintained a fairly conservative approach to investing, favoring retail and banking stocks while giving way to more volatile sectors such as technology and energy . In fact, major US banks have been Warren Buffett’s investment of choice because they are part of the country’s infrastructure, a country on which he constantly gambles.

At the end of 2019, Berkshire still held large stakes in four of the five largest US banks, with Wells Fargo remains Buffett’s largest stock holding for three consecutive years through 2017.

But Buffett seems to have changed his investment ethic quite drastically in recent years, taking new multibillion-dollar stakes in energy and computer companies while eschewing the banking sector.

After the outbreak of the coronavirus pandemic in early 2020, Buffett Wells Fargo (NYSE:WFC), JPMorgan (NYSE:JPM), and Goldman Sachs (NYSE:GS) on the cheap side, despite many stocks in the sector becoming significantly cheaper to own.

“I like banks in general, I just didn’t like the share we had compared to the potential risk if we got the bad results we haven’t had so far.That’s what Buffett said to investors at the shareholders’ meeting last year.

Several analysts have expressed their views on Buffett’s divestments.

“What this tells you is he thinks we should close the shutters because we are looking at a long cycle of inflation and probably stagnation. Banks are very cyclical and all indications are that we are in a high inflation, high interest rate environment for a while What that generally means is that lending activity will be compressed and investment activity will slow downPhillip Phan, a professor at Johns Hopkins Carey Business School, told CNBC.

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Despite rising interest rates this year, which typically boost banks as credit margins improve, the banking sector has taken a beating: WFC is down 18.9% YTD, JPM is down 20.3% while GS is down 12.9 % has lost on concerns that the US economy could stagnate if the Fed fights inflation with rate hikes.

Buffett’s energy investments

Buffett has doubled his energy investments while winding down his banking positions, despite years of high valuations for oil and gas stocks.

The legendary investor has added new shares in red-hot E&P companies Occidental Petroleum Corp. (NYSE: OXY) and Chevron Inc. (NYSE: CVX) despite both currently trading at multi-year highs.

According to Berkshire’s latest 13F filing, the company purchased 118.3 million shares of OXY in multiple transactions from March 12 to March 16, bringing its stake in OXY to 136.4 million shares, or ~14.6% of outstanding shares. Berkshire also holds OXY warrants granting the right to acquire approximately 83.9 million additional shares of common stock for approximately $59.62 each, plus an additional 100,000 OXY preferred shares.

Earlier, Berkshire announced it bought about 9.4 million shares of oil titan Chevron in the fourth quarter, increasing its holding to 38 million shares currently worth $6.2 billion.

OXY has doubled over the past 12 months, while CVX is up 40.9%, with both stocks trading near multi-year highs. But it’s clear Buffet thinks they still have a lot of upside, judging by the huge positions his investment conglomerate has opened up.

You can be sure that Buffett will continue to expand his oil and gas holdings over the next year.

David Rosenberg, founder of independent research firm Rosenberg Research & Associates Inc., has laid out 5 key reasons why energy stocks remain a bargain, despite the fact that oil prices have not made major gains in recent months.

#1. Favorable valuations

Energy stocks remain cheap despite the huge run-up. Not only did the sector far outperform the market, but companies in this sector remain relatively cheap, undervalued and have above-average expected earnings growth.

Rosenberg has analyzed P/E ratios by energy share by looking at historical data since 1990 and found that the industry has historically averaged only in the 27th percentile. The S&P 500 is in its 71st percentile despite the deep sell-off that occurred earlier this year.

Image source: Zacks Investment Research

Some of the cheapest oil and gas stocks right now include Ovintiv Inc. (NYSE: OVV) with a P/E ratio of 6.09; Civitas Resources, Inc. (NYSE:CIVI) with a P/E ratio of 4.87, Enerplus Corporation (NYSE:ERF)(TSX:ERF) has a PE ratio of 5.80, Occidental Petroleum Company (NYSE: OXY) has a PE ratio of 7.09 while Canadian Natural Resources Limited (NYSE:CNQ) has a P/E ratio of 6.79.

#2. Robust earnings

Strong profits from energy companies are a major reason why investors are still flocking to oil stocks.

Third-quarter earnings season is almost over, but so far things seem to be better than feared. According to FactSet earnings insights, 94% of S&P 500 companies have reported Q3 2022 earnings for Q3 2022, with 69% reporting positive EPS and 71% reporting positive revenue surprise.

The energy sector posted the highest profit growth of all eleven sectors at 137.3% vs. 2.2% on average by the S&P 500. At the subsector level, all five industry subsectors reported year-over-year revenue growth: oil and gas refining and marketing (302%), integrated oil and gas industry (138%), oil and gas exploration and production (107% ), oil and gas equipment and services (91%) and oil and gas storage and transportation (21%). Energy is also the sector in which most companies beat Wall Street estimates by 81%. The positive revenue surprises reported by Marathon Petroleum ($47.2B vs $35.8B), Exxon Mobil ($112.1B vs $104.6B), Chevron ($66.6B vs $57.4B ), Valero Energy ($42.3B vs. $40.1B), and Phillips 66 ($43.4B vs. $39.3B) were major contributors to the increase in revenue growth rate for the index since 30 September.

In fact, the outlook for the energy sector remains good. According to a recent Moody’s research report, industry revenues will generally stabilize in 2023, although they will be slightly below the level of recent peaks.

The analysts note that commodity prices have fallen from very high levels earlier in 2022, but they predict that prices are likely to remain cyclically strong through 2023. This, combined with modest volume growth, will support strong cash flow generation for oil and gas producers. Moody’s estimates that US energy sector EBITDA will be $623 billion for 2022, but will decline to $585 billion in 2023.

However, analysts say low investment, growing uncertainty about future stock expansion and high geopolitical risk premia will continue to support cyclical high oil prices. Meanwhile, strong export demand for US LNG will continue to support high natural gas prices.

In other words, there are simply no better places for people investing in the US stock market to park their money if they are looking for serious earnings growth.. Furthermore, the outlook for the sector remains good.

Although oil and gas prices have fallen from recent highs, they are still much higher than in recent years, hence the continued enthusiasm in energy markets. Indeed, the energy sector remains a firm favorite on Wall Street, with the Zacks Oils and Energy sector being the top-ranked sector of all 16 Zacks Classified sectors.

#3. Strong payouts to shareholders

Over the past two years, US energy companies have shifted their previous play from using most of their cash flows for production growth to returning more money to shareholders through dividends and buybacks.

As a result, the combined dividend and buyback yield for the energy sector is now approaching 8%, which is historically high. Rosenberg notes that similar elevated levels occurred in 2020 and 2009, which preceded periods of strength. By comparison, the combined dividend and buyback yield for the S&P 500 is closer to five percent, making for one of the biggest gaps in the energy industry’s favor ever.

#4. Low stocks

Despite weak demand, U.S. inventory levels are at their lowest levels since mid-2000, despite the Biden administration attempting to lower prices by flooding markets with 180 million barrels of SPR crude. Rosenberg notes that other potential catalysts that could lead to additional upward pressure on prices include Russia’s oil price cap, a further escalation in the Russia-Ukraine war, and China’s move away from its Zero COVID-19 policy.

#5. Higher Embedded “OPEC+ Put”

Rosenberg points out that OPEC+ is now more comfortable with oil trading above $90 a barrel, as opposed to the $60-$70 range they accepted in recent years. The energy expert says this is because the cartel is less concerned about losing market share to US shale producers, as the latter have prioritized shareholder payouts rather than aggressive production growth.

OPEC+’s new stance offers better visibility and predictability of oil prices, while prices in the $90 per barrel range could support strong payouts through dividends and buybacks.

Given these factors combined with fears that a recession could hit in the coming year, Buffett and the investment universe will struggle to find a more attractive sector to park their money in 2023.

By Alex Kimani for Oilprice.com

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