XOM - IEO: Finding Opportunity In Upstream Companies

2023-05-31 16:34:31 ET

Summary

• iShares U.S. Oil & Gas Exploration & Production ETF offers a unique set of holdings and an impressive dividend yield of 4.5%.
• The ETF is heavily correlated to oil prices and has a large concentration of upstream companies, making it more volatile than its peers.
• Due to uncertainty in oil prices and the potential impact of interest rate hikes, I rate IEO a Hold.

iShares U.S. Oil & Gas Exploration & Production ETF ( IEO ) offers exposure to small, mid, and large-cap stocks in the exploration and production (E&P) sector. With AUM of about $630M, IEO tracks the Dow Jones U.S. Select Oil Exploration & Production Index using a representative sampling technique. This means the ETF doesn't hold the exact same companies as the index but chooses some that best represent it.

IEO has a very unique set of holdings. One of IEO's greatest strengths is its impressive dividend yield of 4.5% which is more than most energy ETFs. Because this ETF has such a large holding of upstream companies, it's great for an oil bull because upstream companies are most affected by oil prices. With recent macroeconomic changes, I am less confident in oil becoming more expensive. Because of this, I rate IEO a hold.

Holdings

IEO holds 53 companies, all weighted by market cap, with its top 10 holdings making up about 68% of its AUM. One of the biggest differences between this ETF and most other energy ETFs is that it is not heavily skewed to Exxon Mobil ( XOM ) or Chevron ( CVX ). In fact, IEO doesn't hold either of them. Because this is an oil E&P ETF, it excludes large vertically integrated companies. This also means that this ETF can hold mid and small-cap companies. Although this ETF doesn't have a XOM and CVX, I still think it has a concentration problem. In my opinion, ConocoPhillips ( COP ) takes up far too much of IEO's AUM. It is almost double IEOs second-largest holding, EOG Resources, Inc. ( EOG ). If I'm looking for broad exposure to the oil E&P industry, I wouldn't want a single company controlling nearly 20% of the ETF.

Another differentiating feature of IEO compared to a typical energy index ETF like VDE or XLE , is its large concentration of upstream companies, making up about 72% of the ETF. Upstream companies are the most influenced by changes in oil prices. Upstream companies are the ones that find oil and extract it. These services normally have fixed costs, meaning that when they sell the oil, the price per barrel is what determines their profit. Because of this, IEO's performance is very dependent on the price of oil.

Dividends

This ETF offers well above average dividends with a yield of 4.5%. Its yield is higher than the notable energy index ETFs, VDE and XLE, and even other oil E&P ETFs such as PXE. As shown in the chart below, IEO's dividends have had consistent growth over the past year. This growth was consistent while this ETF performed well and poorly. This means that this dividend growth is not just due to a falling ETF price, but due to these companies bringing in enough profit to raise their yield. As long as oil prices stay flat, the yield will likely stay around 4.5%. And if oil prices go up, the trend will likely continue and the yield will rise.

Oil's Uncertain Future

As mentioned before, the ETF is heavily correlated to oil. There is much uncertainty about what's going to happen to oil in the remainder of 2023. Goldman forecasts oil going up to around $110 per barrel while the EIA forecasts oil staying around $75 per barrel.

I'm becoming less bullish on oil as it looks like interest rates may continue to rise. Futures traders are now pricing in a 66% chance of a quarter-point rate hike in June. If this happens, there is reason to believe that the US economy will slow down even more, leading to less consumption and therefore lower oil prices.

While every energy ETF will experience volatility due to this uncertainty, IEO will be hit especially hard. Because of the large concentration of upstream companies in IEO's holdings, a large swing in oil prices will affect IEO more than most other energy ETFs. Also, because IEO doesn't hold XOM and CVX, this ETF holds more smaller-cap stocks, making it already more volatile than its peers.

Conclusion

IEO offers exposure to smaller upstream companies. Although it does not hold XOM and CVX, COP still is overweighted. IEO has an impressive dividend yield of 4.5% and excellent dividend growth history. This is a strong ETF to buy if oil is going to go up, but I don't see enough evidence to justify investing in this ETF. Because of this, I rate IEO a Hold.

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