Data as of November 30, 2019 unless otherwise noted.

PERFORMANCE (TOTAL RETURNS)
BENCHMARKS NOVEMBER 2019 YTD
Alerian MLP Index (AMZX) -5.75% -1.82%
Alerian Midstream Energy Select Index (AMEIX) -2.03% 12.68%
ICE BofAML U.S. High Yield Energy Index (HY Energy) -0.39% -0.05%
S&P 500 Energy Index (S&P Energy) 1.82% 5.46%
Performance data quoted represents past performance and is no guarantee of future results. An investment cannot be made directly in an index.

Energy subsectors diverge as market looks ahead: Energy performance diverged in November, as S&P Energy gained 1.8%, HY Energy declined modestly, and midstream indexes fell. WTI crude rose $1/bbl and continued to trade in the mid-$50s/bbl for much of the month.1 Even with a positive month, the S&P Energy again underperformed broad markets and is on track to significantly lag every other equity sector for the year. Meanwhile, the midstream sector continued its weak second half of the year; since a peak on July 11, the AMEIX and AMZX have lost 10.64% and 18.43%, respectively. Despite decent U.S. supply growth this year, markets continue to worry about volumes for next year and beyond, as consistently subdued oil prices have forced a 24% decrease in rig counts since the beginning of the year.1 HY Energy fell modestly, as lower-rated bonds continued to underperform. For the year, BB rated energy bonds have returned 5.74% and B rated issues are about flat, while CCC rated energy debt has declined nearly 37%.1 Attention will be squarely on OPEC+ in December, as the group’s production policy going into 2020 will be key for energy markets.

Taking a look at energy valuations going into 2020: No matter which measure you use, equity market valuations appear expensive after a stellar 2019. The energy sector remains one of the only areas of the equity market where valuations do not appear quite as steep. Large-cap energy stocks are currently valued at a 7x EV/EBITDA multiple, which is just above the median since 2010.2 Compare this with the rest of the equity market, where almost every sector is trading at or near the top of its post-GFC valuation range. In the midstream sector, valuations appear even lower, as stock prices have slumped even with the space experiencing solid earnings growth. Valuation multiples for the AMZX and AMEIX currently sit at 9.0x and 10.7x, respectively, both in the bottom quartile over the past decade. Additionally, E&P firms, which have seen extended declines over the past year and a half, are near a decade-low multiple.3 Of course, there are reasons why markets are hesitant to put higher valuations on energy firms. For upstream-focused sectors, commodity prices have been too low for too long, and there is risk that oversupply next year will keep prices low. For midstream, there are concerns that the best years of U.S. production growth are in the rearview mirror. Additionally, infrastructure firms face the risk of having to deal with broken contracts if some E&P companies come under stress. However, we see valuations as attractive going into 2020, especially in the midstream space. The long-term thesis remains intact, as the U.S. continues to produce at record levels and will soon become a net exporter of energy. As firms continue to shore up their balance sheets, we could see some reversion to the mean for valuations in 2020.

KEY TAKEAWAYS

  • Large-cap energy gained while the midstream sector sold off in November.
  • Energy valuations appear relatively cheap heading into 2020.

1 Baker Hughes.
2 Bloomberg Finance, L.P. EV/EBITDA measures the ratio of a company’s enterprise value to its estimated 12-month forward EBITDA (earnings before interest, taxes, depreciation, and amortization).


Index descriptions: Alerian MLP Index is the leading gauge of energy Master Limited Partnerships (MLPs) and is a float-adjusted, capitalization-weighted index, whose constituents represent approximately 85% of total float-adjusted market capitalization. Alerian Midstream Energy Select Index is a composite of North American energy infrastructure companies and is a capped, float-adjusted, capitalization-weighted index, whose constituents are engaged in midstream activities involving energy commodities. ICE BofAML U.S. High Yield Energy Index is designed to track the performance of U.S. dollar-denominated high yield rated corporate debt publicly issued in the U.S. domestic energy market. S&P 500 Energy Index comprises those companies included in the S&P 500 that are classified as members of the Global Industry Classification Standard (GICS) energy sector.

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This energy market commentary and any accompanying data is for informational purposes only and shall not be considered an investment recommendation or promotion of FS Investments or any FS Investments fund. The energy market commentary is subject to change at any time based on market or other conditions, and FS Investments and FS Investment Solutions, LLC disclaim any responsibility to update such energy market commentary. The energy market commentary should not be relied on as investment advice, and because investment decisions for the FS Investments funds are based on numerous factors, may not be relied on as an indication of the investment intent of any FS Investments fund. None of FS Investments, its funds, FS Investment Solutions, LLC or their respective affiliates can be held responsible for any direct or incidental loss incurred as a result of any reliance on the energy market commentary or other opinions expressed therein. Any discussion of past performance should not be used as an indicator of future results.