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Oil and gas companies are trading at heavy discounts to their peers, even with high oil prices. The average ASX 200 trailing P/E is 15.8x while the average for the energy sector is just 5.8x.
Why does Mr Market discount oil and gas companies so heavily?
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Check our buy/sell tips on the top Oil and Gas Stocks in ASX
Why oil and gas companies trade at low multiples
Oil and gas companies are known to trade at low multiples for four key reasons: Changing market conditions, environmental concerns, high capex and regulation.
1. Changing market conditions
One of the primary reasons is the volatile nature of the oil and gas industry, where market conditions can change rapidly and significantly affect the company’s financial performance.
Investors in oil and gas companies will remember that oil prices have been high during 2022 due to the Russia-Ukrainian war. But it was only a couple of years earlier when oil prices briefly fell below zero as COVID-19 decimated industrial production and aviation.
Investors should also remember the influence that OPEC have. By controlling the supply of oil and adjusting pricing strategies, OPEC can impact oil prices around the world. And circumstances in the industry can change far more rapidly than most other sectors.
2. Concerns over the environmental impact
Another significant factor is the increasing concerns over the impact of burning fossil fuels on the environment, which has led to rising demands for cleaner and sustainable energy sources. The burning of fossil fuels is contributing to climate change, which has become a pressing global issue.
For several years, there has been a growing awareness and concern for the environment, leading investors to prioritize companies that prioritize environmental sustainability. But after several years where oil and gas companies had cheaper production than renewables, the tide has turned. As more and more money is invested in renewable energy, economies of scale develop for individual companies and product.
Moreover, governments around the world are implementing more stringent regulations on emissions, forcing oil and gas companies to invest heavily in environmental compliance measures, which can limit their profitability.
Investors are recognizing that the transition towards a low-carbon economy is inevitable. Investing in oil and gas companies is perceived as outright denial of the future or as a move delaying the inevitable.
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3. High capex
Oil and gas companies have high capex due to the nature of their business. Exploration for oil reserves, drilling, and the development of new oil fields require a significant amount of capital expenditure. These companies invest large sums of money in research and development to find new and more efficient ways to extract oil and gas from the ground.
Additionally, oil and gas companies must regularly replace aging infrastructure, such as pipelines and oil rigs, to ensure safe and efficient production.
We also note that the high capex is also due to the constantly changing regulatory, geopolitical and environmental landscapes. This not only translates to high borrowing costs but also reduces the company’s profitability.
Lastly, the oil and gas industry is subject to government interventions, regulations, and tax policies that can significantly impact the company’s profitability.
The changing regulatory environment can create volatility and uncertainty for oil and gas companies, making investors skeptical and causing stock prices to decline.
Oil and gas companies trade at low multiples for good reasons
In conclusion, oil and gas companies trade at low multiples due to several factors, including volatile market conditions, environmental concerns, capital-intensive operations, geopolitical instability, and changing regulatory policies.
Investors should carefully evaluate these factors before investing in any oil and gas company’s stock. There are some sectors that present low risks to investors, but the oil and gas sector is not one of them.
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