The PXE Energy ETF: The Trend is Your Friend (NYSEARCA:PXE)

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As most of you know, the energy sector has been by far the best performing equity sector during the 2022 bear market (see chart below). In fact, apart from the Public Service Sector SPDR (XLU), is the only sector in the green. Given the macro environment: Russia’s invasion of Ukraine and resulting actions that have effectively disrupted the global energy supply chain, OPEC+’s decision to cut production and advocate a higher price range for Brent (an estimated $85-$95/bbl), and the relatively new discipline of domestic shale producers, as well as relatively low global storage levels: the outlook for the future remains bullish in my view. That being the case, the trend is your friend, and despite this year’s outsized returns, O&G stock could have a lot more potential. One option that investors should consider is diversified exposure to the sector through the Invesco Dynamic Energy E&P ETF (NYSEARCH:PXE). Today I will take a closer look at this ETF and see if it can fit well into your portfolio.

Performance of the equity sector in 2022

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investment thesis

As stated above, the global oil macro environment remains quite bullish in my opinion. Here in the US, keep in mind that wells drilled but not completed (“DUC”) have fallen sharply since the destruction of demand and prices caused by the global pandemic forced E&P companies to stop drill new wells and instead focus on completing existing DUCs:

DUC

EIA

Having a significantly lower DUC inventory, combined with an increased oil patch inflation and the new spending discipline of national exploration and production companies means that growing oil production faces major obstacles. Even drawing down strategic petroleum reserve (“SPR”) at the lowest level since the early 1980s has done little to reduce the price of oil and gasoline.

That being the case, inflation and high gas prices are likely to be a thorn in the side of consumers (and investors…) for some time. As a result, investors should protect their portfolio with at least a market weight in energy or, in my opinion, an overweight position. Consider the current weight of the SPDR Energy ETF (XLE) in the S&P 500 is only 5.6%. Note also that the top performing stocks in the S&P 500 this year have been dominated by E&P players:

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Top 10 S&P500 Actors

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Now, let’s take a look at the PXE ETF to see how it has positioned investors for future success.

Top 10 Holdings

The top 10 holdings in the Invesco Dynamic Energy E&P ETF shown below were taken directly from Invesco PXE ETF Website and equal to what I consider a moderately concentrated 46% of the entire portfolio of 30 companies:

PXE ETF Top-10 Holdings

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The first observation I have is that four of the top 10 positions can also be found on the S&P500 Top 10 Players list (ie the chart above).

Participation No. 1 with a weight of 5.7% is ConocoPhillips (POLICEMAN). Conoco has become a Permian powerhouse after buying Concho Resources and most of Shell’s Permian assets at the bottom of the cycle during the pandemic. COP also has excellent Brent-based production and global LNG assets. The company generated $4.7 billion (or an estimated $3.70 per share) of free cash flow in the third quarter. That led to an 11% increase in the quarterly dividend and added an additional $20 billion to the existing buyback program, which now stands at $45 billion, or 27% of the current market cap of $164.8 billion from the company. Watch COP drills a jet in the third quarter for more information on how the company performed in the third quarter. As explained in that article, COP has a dividend policy (base + variable) and it is estimated that it yields 3.6%.

Refiner and midstream operator Marathon Petroleum Corp. (MPC) is the #3 holding company with a weight of 5.2%. Along with tenure No. 4 Valero (VLO), refiners equate to a ~10% allocation within the top 10 holdings. As I explained in my recent Seeking Alpha article on Philips 66 (PSX), refiners have been making it this year with a higher margin (especially for diesel) due to the general lack of refining capacity, the difference between Brent and WTI, and the deep discount of WCS feedstock imported from Canada (see PSX: Spring Has Sprung):

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Data by YGraphics

Pioneer Resources (PXD) is holding No. 6 with a weight of 4.6%. PXD has a very shareholder-friendly management team, and unlike COP, a company that overly emphasizes share buybacks, prioritizes returning cash to shareholders in the form of dividends paying a whopping $25.44/share in dividends this year:

Dividends PXD 2022

Pioneer Natural Resources

Western Petroleum (OXY) is holding company No. 8 and a (the?) high-yielding stocks across the S&P 500 this year. As I explained in my recent Seeking Alpha article, OXY has been one of the main beneficiaries of Russia’s invasion of Ukraine, and the resulting surge in oil and gas prices, because it allowed the company to greatly accelerate your debt payment plan. In fact, in the first two quarters of 2022, OXY was able to reduce long-term debt by a whopping $8.1 billion. The company was even able to significantly increase its dividend and began to buy back shares. Watch: Why OXY is among the best performing stocks in the S&P500 this year.

APA Corporation (APA), the old Apache, completes the top 10 with a weight of 3.2%. APA is generally considered to be a more gassy game considering its massive alpine discovery. APA is +71% this year and yields 2%.

Valuation Metrics

Despite the big gain in the fund this year, PXE still trades at a significant discount to the broad S&P 500:

PXE ETFs S&P500
P/E ratio 5.32x 19.66x
Forward price/earnings ratio 4.33x 18.01x
Price-to-book ratio 2.13x 3.77x
ROE 36.44% 11.8%

Performance

The long-term performance of the PXE ETF is shown below:

PXE ETF Performance

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As can be seen from the chart, the fund’s three-year – and even five-year – average annual return is excellent. Note, however, that the 10-year returns incorporate the “lost decade” when the energy sector was the worst-performing sector in the entire market.

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The chart below compares PXE’s price performance to some of its peers during the 2022 bull market for oil and gas stocks: SPDR Energy ETF (XLE), the Cutting Edge Energy ETF (VDE), and the iShares Global Energy ETF (IXC):

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Data by YGraphics

PXE comes out above the chosen funds.

risks

The main risk of investing in the PXE ETF is that the prices of oil, gas and refined products could fall. That could be the result of increased production or due to demand destruction as a result of the global economic contraction.

Note that the PXE does not own the major integrated oil companies like Exxon and Chevron. That being the case, the portfolio is not as exposed to the downstream (think chemicals and refining) compared to many energy funds. That strategy works well during oil and gas price bull cycles, but not so well in bear cycles where downstream assets can help offset weakness in upstream.

While the 0.63% expense fee is pretty stiff, you can’t argue with the fund’s outperformance.

Summary and conclusion

With many of the major domestic oil and gas producers and refiners, the PXE ETF has been a great place to have your money during the 2022 bear market. With that being said, I believe the macro environment going forward is bullish and the “trend is your friend.” Meanwhile, the ETF remains significantly undervalued compared to the S&P 500 and on an ROE basis.

Bottom line: Investors hit by “pain at the pump” and inflationary pressures across the board, not to mention hit by the 2022 bear market, had better consider setting, or raising, the exposure to the energy sector in the future. PXE is a purchase.

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