Another Way To Oil

By Traders Huddle | May 04, 2012 AAA

New York, May 3rd (TradersHuddle.com) - Analyze enough equity-based oil ETFs and one quickly comes to the conclusion that Exxon Mobil (NYSE: XOM), Chevron (NYSE: CVX) and just a couple of other oil industry behemoths dominate most of these funds. For conservative investors that just cannot make up their minds about what integrated oil stock to own, the fact that an ETF such as the Energy Select Sector SPDR (NYSE: XLE) devotes about a third of its weight to Exxon and Chevron is a good thing.

The other side of the coin is oil ETFs are just like scores of other sector funds: The more risk an investor is willing to take on, the higher the potential rewards. That's exactly why the SPDR S&P Oil & Gas Exploration & Production ETF (NYSE: XOP) merits consideration.

Oil stocks and the ETFs they call home are by nature "high beta." XLE's beta is 1.05, but XOP blows that away with a beta of 1.24, meaning XOP is far more sensitive to the broader market's whims than XLE. In reality, the XOP/XLE comparison isn't an apples-to-apples match up. While a sizable chunk of XLE's weight is tied up in just two mega-cap stocks, XOP is essentially an equal-weight product. Home to 75 stocks, XOP allocates no more than 1.9% to any single name.

A near equal-weight composition is just one alluring element to XOP. Another is what stocks are featured in the ETF's lineup. Many, perhaps too many, oil ETFs focus exclusively on large and mega-cap names. Indeed, Chevron and Occidental Petroleum (NYSE: OXY) call XOP, but their weights are not significant enough to overpower the ETF at large. Overall, integrated names represent just 7.2% of XOP's weight.

Refining plays garner an allocation of 13.5%. Where we're going with this is to say XOP is really about independent oil and gas producers, otherwise known as the true growth companies of the energy sector. The weighted average market cap of XOP holdings is less than $17.6 billion compared to a whopping $131.6 billion for XLE.

In other words, XOP's constituency is more nimble. These companies can take more chances with high risk/high reward projects and the earnings growth they can offer far outpaces their stodgier peers. That higher EPS growth translates into better returns to shareholders and the still reasonable market values make many mid-cap and smaller big-cap oil and gas names valid takeover targets.

Yes, that is another reason to consider XOP. Of its 75 holdings, it not a stretch to say 10 or 12 or credible acquisition targets. For now, have a look at XOP's chart. Get long if the ETF bounces off support at $52. Head for the hills if oil prices fall dramatically because XOP could head back to the mid-$40s in that scenario.

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