Amid Dearth Of Value, European Oil & Gas Looks Cheap

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With value outperforming in 2013 and unrealized profits baked into a lot of current valuation levels, it’s getting difficult to find attractive stocks, but Societe Generale equity analyst Irene Himona thinks there are still value plays to be made, at least in the short term, and that investors should take a second look at the oil and gas sector in particular.

Oil, along with metals & minerals and utilities, are currently the cheapest sectors in Europe compared to their historical valuations, but oil is also cheap judging by its price to net book value ratio.

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Soc Gen: Oil price not sector’s main driver

“The main driver of the sector’s performance vs the overall market, is not simply the oil price, which determines a portion of revenues but is not a good proxy for EPS, but rather it is the sector’s EPS momentum relative to that of the market,” write Himona. “When consensus EPS for the sector is upgraded faster than for the market (or downgraded slower, as in 2009), oil companies will correspondingly outperform – and vice versa.”

Right now the oil sector is trading at a 30% discount to the rest of the market, its cheapest level in five years, with only mid-2010 even coming close.

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European refineries struggling with US competition

But sometimes low valuations really are the sign of a struggling business. There’s no denying that the European oil sector has had a rough year as American shale has pushed it up the cost curve, causing some refineries to lose money, but Societe Generale argues that since oil production and reserves are growing once again, capex can be reduced and free cash flow should get a big boost. They pin the single-digit valuation levels on the market’s tendency to get stuck in an analytical rut that doesn’t take recent developments into account, but the counter argument is that unprofitable European refineries should simply be closing and that rising production actually puts pressure on prices and creates greater long-term problems.

Societe Generale specifically recommends Total SA (ADR) (NYSE:TOT) as a promising stock, and the sector could be ripe for stock picking strategies as less efficient companies (say, Motor Oil Hellas (OTCMKTS:MOHCY)) bring down the valuation for companies that are still doing well.