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BofA/Merrill Lynch Downgrades Energy Sector to Marketweight; Likes Staples, not Discretionary as Anti-Oil Play

December 2, 2014 8:28 AM EST
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BofA/Merrill Lynch strategist Savita Subramanian lowered his rating on the Energy Sector from Overweight to Marketweight following the OPEC decision. With OPEC’s decision to maintain, rather than modestly cut production, the firm's strategists now see $70-$75 as the 2015 range for Brent, a drop from the prior forecast of $90. They now sees a more balanced risk-reward in the sector.

While the sector looks cheap, the firm warns of value traps. "With the collapse in crude, the sector now trades at a 20% discount to the S&P 500 where it has historically traded in-line with the market... But further estimate cuts are likely to come, and our tactical industry rotation model identifies Energy as a value trap – prices are falling faster than earnings are deteriorating."

If oil stays in the $70s, they see $3-4 downside to 2015 EPS forecast of $126, putting EPS growth at 3-4% instead of 6-7%.

The firm also warns price volatility spells multiple compression. The firm's commodity strategists believe WTI could fall as low as $50 in the coming month. "Volatility in oil prices translates to volatility in earnings, and investors will need to be compensated for that risk by a higher premium," the strategist said. "The good news is that multiple compression may not be severe as one might expect, given Energy has barely rerated over the last four years."

For exposure to the sector, the firm prefers big, lower beta stocks like ExxonMobil (NYSE: XOM).

Commenting on anti-oil plays, the firm likes Consumer Staples, not Consumer Discretionary. "In fact, the percentage of stocks with negative oil price betas in Consumer Discretionary is just 33%, where the percentage in Consumer Staples is 79%," the analyst said. Low-end retailers are some of the biggest beneficiaries they said.



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