ASX mining stocks have been hot favourites with investors but it could be time to rotate out of these outperformers and into oil and gas stocks, according to Morgans.
The S&P/ASX 300 Metal & Mining (Index:^AXMM) (ASX:XMM) index has rocketed up 16% over the past six-months when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) and S&P/ASX 200 Energy (Index:^AXEJ) (ASX:XEJ) indices have shed about 4% each.
Investors have been taken by our miners as commodity prices have outperformed expectations in 2018 and coffers in the sector have been overflowing with cash, which in turn is fuelling expectations of more capital returns like special dividends.
This thematic has benefitted the likes of the BHP Group Ltd (ASX: BHP) share price, Rio Tinto Limited (ASX: RIO) share price, South32 Ltd (ASX: S32) share price and Independence Group NL (ASX: IGO) share price.
Miners close to full valuations
However, Morgans thinks the “easy gains” have been made and it’s time for investors to shift their focus on the better value energy sector.
“This reporting season we are faced with a wide disconnect in themes playing out across several commodity markets. Bulks have enjoyed continued strength, particularly in iron ore, which has pushed the majority of bulk producers near or beyond our price targets,” said Morgans.
“While at the other end of the spectrum we have continued volatility in oil prices leaning heavily on investor sentiment in energy stocks. We believe this sets up a clear opportunity to take profits from iron ore and coal producers to reinvest in cheaper energy names this reporting season.”
The broker said its analysts have just returned from the US where they’ve spoken with several oil and gas producers.
Oil stocks better priced
They noted that confidence in the sector is surprisingly low with several producers planning on cutting production in the near-term.
This is despite the fact that crude oil prices have rebounded from their lows since the start of the 2019 calendar year.
“This has made us more confident in the prospects of a further oil price recovery given the contrast this presented to the popular view covered in the media that shale oil output is more robust than pundits give it credit for,” said the broker.
“With share prices across our coverage universe showing implied oil prices around current spot, and with oil prices in our view likely to recover sometime this year, we see now as a good opportunity to increase exposure to the energy sector.”
The standout large cap stock in the energy sector is Woodside Petroleum Limited (ASX: WPL), according to Morgans as the liquified natural gas (LNG) market continue to outpace expectations.
Meanwhile, Morgans’ small cap star pick in the sector is Otto Energy Limited (ASX: OEL) after the junior made a promising discovery at its Lightning prospect.
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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited, Rio Tinto Ltd., and South32 Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.