Thanks for another excellent video. The table you presented in the video has made me ponder the vast valuation differences in today's market. It seems that the dominance of the passive index investing has caused large valuation differences among different sectors and even among different companies in a same sector. The passive buying or selling purely depends on money in or out flow and does not give any consideration on valuation (as long the company is in the index). Because of this inefficiency, it can take a long time for the market to recognize and reward the performance. In the case of the $MUSA cited in your video, its stock price did not really take off until 2021. The inefficiency has probably contributed to the underweight of energy sector in S&P 500. There are some medium (small by the standard of the US) Canadian E&Ps that have comparable scale of buybacks and profitability. But their stock total returns (and thus valuation) are just a fraction of those of $MUSA.
On MUSA, your observation that it took some time is spot on. The role of passive is complex but agree it is having an impact. Interesting to hear about some Canadian E&Ps that have been committed to similarly scaled buybacks.
I'm a longtime index-only investor, but the incredibly low valuations in the energy sector + the simple idea that we have not reached peak demand globally appeared to me to be a very compelling case for energy investing during this period, so I began investing in the energy sector around 2021.
Here is an example. Parex Resources is a Candian company operating in Colombia. I made a few comparison charts of PXT and MUSA (in an X group to discuss your video of this week).
In last 8 years, MUSA bought back 47% of SO while PXT bought back 33%. But there is a wide difference in 8-year total returns of MUSA (583%) vs PXT (98%)
The president of Colombia, after got into office in 2022, placed a ban on any new exploration license. As a result, Wall Street put a magnified lens on the resource and reserve of each E&P company in Colombia. At the end of 2023, the after-tax NAV of PDP, 1P and 2P were US$18.9, US$22.8 and $30, respectively, at 10% discount rate. The stock (PARXF) closed at US$15.50 on Friday.
From that basic premise, I worked with people I considered experts in energy to develop a strategy. From my understanding the opportunity in energy during this cycle (let's mark the start of this cycle from the April 2020 negative price) is something like this:
1. Because of the previous cycle's destruction of value, plus the COVID demand hit, and ESG, and peak demand, traditional energy's valuations were rock bottom in 2020.
2. Investors know about the low valuations and the low CAPEX, but many don't see this as a huge distortion because of the IEA's messaging about peak global demand ("sunset industry" "stranded assets" 'Net zero 2050 report'). If traditional energy is dying, these are just liquidation sales, the thinking goes.
3. Then we'd have to figure out the specifics of what method is best to invest in the energy sector, and that's where the experts came in. The strategies seemed to centre ('cent-re', I'm Canadian LOL) around a combination of limiting CAPEX, stock buybacks when share prices are low and dividends when share prices are high.
To me, the energy sector is an opportunity during this phase of this cycle not because it has unlimited growth ahead of it, but because investors are way undervaluing a mature industry (again, during this phase of this cycle). What do you all think? Trying to summarize the investment case.
good stuff Investor. Definitely a max/optimized long-term buyback is one way for energy companies to outperform...patience is required. I will say there likely are select opportunities for growth...and M&A is an alternative as well.
Hi Arjun,
Thanks for another excellent video. The table you presented in the video has made me ponder the vast valuation differences in today's market. It seems that the dominance of the passive index investing has caused large valuation differences among different sectors and even among different companies in a same sector. The passive buying or selling purely depends on money in or out flow and does not give any consideration on valuation (as long the company is in the index). Because of this inefficiency, it can take a long time for the market to recognize and reward the performance. In the case of the $MUSA cited in your video, its stock price did not really take off until 2021. The inefficiency has probably contributed to the underweight of energy sector in S&P 500. There are some medium (small by the standard of the US) Canadian E&Ps that have comparable scale of buybacks and profitability. But their stock total returns (and thus valuation) are just a fraction of those of $MUSA.
On MUSA, your observation that it took some time is spot on. The role of passive is complex but agree it is having an impact. Interesting to hear about some Canadian E&Ps that have been committed to similarly scaled buybacks.
I'm a longtime index-only investor, but the incredibly low valuations in the energy sector + the simple idea that we have not reached peak demand globally appeared to me to be a very compelling case for energy investing during this period, so I began investing in the energy sector around 2021.
Arjun:
Here is an example. Parex Resources is a Candian company operating in Colombia. I made a few comparison charts of PXT and MUSA (in an X group to discuss your video of this week).
In last 8 years, MUSA bought back 47% of SO while PXT bought back 33%. But there is a wide difference in 8-year total returns of MUSA (583%) vs PXT (98%)
https://x.com/messages/1687348103295467520/media/1801841122677022853
As an E&P, PXT has more volatile ROCE (especially in 2020, but still profitable). The ROCEs of MUSA and PXT are comparable in last 5 years.
https://x.com/messages/1687348103295467520/media/1801841172207517972
But PXT has much cheaper valuations, whether by EV/EBITDA, P/E or dividend yield, than MUSA. See this chart
https://x.com/messages/1687348103295467520/media/1801983669311340800
The president of Colombia, after got into office in 2022, placed a ban on any new exploration license. As a result, Wall Street put a magnified lens on the resource and reserve of each E&P company in Colombia. At the end of 2023, the after-tax NAV of PDP, 1P and 2P were US$18.9, US$22.8 and $30, respectively, at 10% discount rate. The stock (PARXF) closed at US$15.50 on Friday.
Thanks so much Tonyforever for passing along the Parex example.
I probably should have link the 3 charts directly. Here they are
https://ton.x.com/i/ton/data/dm/1801841122677022853/1801841114594615296/v-1pyv3W.jpg:large
https://ton.x.com/i/ton/data/dm/1801841172207517972/1801841161776283649/MSeCZiax.jpg:large
https://ton.x.com/i/ton/data/dm/1801983669311340800/1801983660041932801/E0LU6CT_.jpg:large
From that basic premise, I worked with people I considered experts in energy to develop a strategy. From my understanding the opportunity in energy during this cycle (let's mark the start of this cycle from the April 2020 negative price) is something like this:
1. Because of the previous cycle's destruction of value, plus the COVID demand hit, and ESG, and peak demand, traditional energy's valuations were rock bottom in 2020.
2. Investors know about the low valuations and the low CAPEX, but many don't see this as a huge distortion because of the IEA's messaging about peak global demand ("sunset industry" "stranded assets" 'Net zero 2050 report'). If traditional energy is dying, these are just liquidation sales, the thinking goes.
3. Then we'd have to figure out the specifics of what method is best to invest in the energy sector, and that's where the experts came in. The strategies seemed to centre ('cent-re', I'm Canadian LOL) around a combination of limiting CAPEX, stock buybacks when share prices are low and dividends when share prices are high.
To me, the energy sector is an opportunity during this phase of this cycle not because it has unlimited growth ahead of it, but because investors are way undervaluing a mature industry (again, during this phase of this cycle). What do you all think? Trying to summarize the investment case.
good stuff Investor. Definitely a max/optimized long-term buyback is one way for energy companies to outperform...patience is required. I will say there likely are select opportunities for growth...and M&A is an alternative as well.
Looking for critical feedback. Does the above framework make sense? Or is it simplistic or flawed in some way? I'm very curious.
A great episode, as always. Congratulations on becoming an empty nester. I’ll bet you are an awesome father. Happy Father’s Day!
thank you Martin on all points! and you too!!!