An April 1st report from FactSet Insight highlights that industry analysts are currently bullish in their price targets on the energy sector despite oversupply conditions leading to very low oil and gas prices. FactSet Senior Earnings Analyst John Butters digs into the numbers to try and come up with a reasonable explanation for this apparent contradiction and the fact we’re now seeing lower overall analyst ratings but relatively higher price targets.

Energy Sector

Analysts have bullish price targets for energy sector

Butters first highlights that energy industry analysts became more pessimistic in their outlook for the sector during the first quarter. In fact, the energy sector saw the largest increases in the number of Hold ratings and Sell ratings among all sectors during the three-month period.

However, in terms of their target prices, industry analysts are still quite optimistic about the energy sector. Energy enjoyed the largest upside difference (+11.6%) between the bottom-up target price ($638.27) and the closing price ($565.76) among all 10 sectors as of March 31. This means, based on a sum of their price targets, that energy analysts are anticipating that the sector will see the largest price increase (+11.6%) among all sectors over the next year.

Energy Sector

Reasons for analyst optimism

One possible reason for analyst optimism is that they believe the sector is undervalued. The forward 12-month P/E ratio for the energy sector is 27.9 right now. This is the highest forward P/E ratio among all 10 sectors in the index. It is also much higher than the 16.7 forward 12-month P/E ratio for the S&P 500 as a whole. The current forward P/E ratio for the energy sector is also notably higher the 10-year average of 12.1 for the sector. On a percentage basis, the forward 12-month P/E ratio for the energy sector is 130% higher than the 10-year average (27.9 compared to 12.1).

It’s also possible energy industry analysts think the price of oil is will rise in the relatively near future. The current mean analyst target price for crude oil (WTI) for 2015 is $56.92. That is around 17% higher than Wednesday’s $48.68 closing price for crude oil. Goldman Sachs has a different point of view. As reported by ValueWalk last month, GS is calling for crude oil to fall to $40 a barrel later this year.

Energy sector firms with target price upside

Energy Sector

Butters created a table listing the 10 firms in the energy sector that had the largest upside differences between the mean target price and closing price as of March 31. CONSOL ENRGY (#5), Chesapeake Energy Corporation (#6), Southwestern Energy (#7), and Range Resources Corporation (#8) all ranked in the top 10 among S&P 500 firms for the greatest upside differences between the mean target price and the March 31st closing price.