IEZ - IEZ: Energy Investors Can Skip This One

2023-05-26 08:51:05 ET

Summary

• IEZ tracks the Dow Jones U.S. Select Oil Equipment & Services Index.
• IEZ pays low dividends, is not well diversified, and is not in a position to outperform a typical energy index.
• I rate IEZ a sell based on a 12-24 month outlook.

iShares U.S. Oil Equipment & Services ETF ( IEZ ) is an inferior choice to a typical energy index such as Vanguard Energy Index Fund ETF Shares (VDE) or Energy Select Sector SPDR Fund ETF (XLE). With an AUM of $183M, the goal of IEZ is to track the Dow Jones U.S. Select Oil Equipment & Services Index using a representative sampling technique. The ETF and its index are rebalanced quarterly.

While the companies held by IEZ don't directly profit based on the price of oil, the stock prices of these companies are heavily influenced by it. The ETF has a dividend yield of a little under one percent, well below the average for ETFs dealing with the energy sector, and a pretty heavy expense ratio of 0.39%.

I think IEZ is poised to underperform a traditional energy index. Both are heavily correlated with oil, but a few factors such as dividend yield, concentration risk, and reputation risks make this ETF a Sell for me.

Holding Analysis

IEZ is made up of 33 different companies, all involved in oil equipment & services. These companies are weighted by market cap. IEZ's top 2 holdings, Schlumberger NV ( SLB ) and Halliburton Co ( HAL ), make up about 41% of this fund. The top 10 holdings comprise about 76% of the AUM, leaving only 24% for the other 23 holdings. This ETF is heavily skewed to the top, especially toward its top two holdings.

Oil Correlation

Energy industry stocks are obviously very correlated with the price of oil. Oil equipment & services industry stocks are no exception. Shown below is a 5-year correlation graph of the price of oil and a traditional market cap-weighted energy index ETF, VDE.

The correlation remained close to 1 (perfect correlation) pretty steadily and most of the time when it dipped, it only dipped to about 0.75 and then shot back up to almost 1. The following correlation chart shows the 5-year correlation between the price of oil and IEZ.

The two correlation graphs are almost identical, both demonstrating a generally high correlation with oil, but also showing that at some points, they diverge. They diverge about 6–9 months after a recent drop in oil prices, as we are experiencing right now and saw back in late 2020. Although IEZ's companies' profits are not as directly affected by the price of oil as would be the profits of an oil company, oil price swings still impact these companies' future outlook. When the price of oil rises, producers ramp up operations, and the demand for oil equipment and services increases.

When IEZ Outperforms

As the chart shows, VDE outperforms IEZ by about 20% most of the time over the last 5 years, with the two exceptions being late 2020 and the beginning of 2023. About 6 to 9 months before each of these events, there was a substantial drop in the price of oil, from $100 to $20 and $90 to $60 respectively. This is because, as mentioned before, these two are highly correlated, but not perfectly. Cheaper oil prices affect energy indexes’ companies’ profits far more than the companies held by IEZ causing IWZ to outperform. Cheaper oil changes IEZ’s companies’ future outlook based on how much demand there will be for their products, but oil will continue to be produced, and oil companies will need the services of IEZ’s holdings.

IEZ has already returned after oil’s recent dip to about even with VDEs 6-month total return performance, and if past patterns continue, it has had its moment of outperformance and will in the near future reach an underperformance of around 20%.

Dividend Yield

IEZ has an extremely low dividend yield of 0.96%, whereas a typical energy index ETF like VDE has a yield of 4.2%. If both move closely with oil, but an energy index pays out 3% more, over time that dividend from the energy index will eventually cause significant outperformance in terms of total return. I don't see any reason to believe that IDE would raise its yield in the future. If there are 2 ETFs with the goal of giving exposure to the energy sector, both are extremely correlated with the price of oil, but an energy index pays out 3% more a year, so there is no reason to own IEZ.

Top Holdings

Schlumberger and Halliburton together make up about 41% of IEZ. Although, as discussed above, this ETF is heavenly correlated with oil, implying these two companies are also, I believe they may also underperform even compared to oil. The two are not just overvalued (see Quant Factor Grades below), but SLB has a history of making poor (and sometimes illegal) business decisions.

I worry about owning an ETF that owns this stock as a significant portion of its AUM because of some of its past actions. Probably their most controversial events happened in 2015 when they agreed to plead guilty and pay over $232.7 million for violating US sanctions by facilitating trade with Iran and Sudan . They also decided to continue providing their products and services to Russia after Russia's invasion of Ukraine. They have boosted their business in Russia by cherry-picking service and equipment contracts from rivals who left . Some may see this as just being a business trying to make money, but I see it as a company willing to take too much risk to produce a profit. These kinds of actions pose reputation risks and political risks. Because SLB is so large and dominates this sector, it is extremely unlikely that it will ever only be a small portion of this ETF, making this ETF too exposed to reputation and political risks now, and also in the future.

Oil's Unknown Future

The elephant in the room is of course the heavy social pressure to move the economy away from oil. The transition has already started with the movement toward greater use of renewable energy sources as alternatives to oil. As discussed before, IEZ moves with oil. If over the long term, oil begins to get cheaper and cheaper, IEZ is expected to do likewise.

Probably the worst time to buy this ETF would be when oil prices are flat. An energy index and IEZ would both be relatively flat in these circumstances, but the energy index would still produce a high dividend yield. The EIA forecasts a relatively flat oil price until 2025. If this is the case and energy goes nowhere for a while, owning a flat energy index that pays better dividends is a better option than owning a flat IEZ that pays almost nothing.

Conclusions

ETF Quality Opinion

IEZ is highly correlated with oil but does not have the benefit of a high dividend yield like most energy indexes and also carries reputation risk. Unless you are bullish on SLB or HAL, I don’t see a reason to buy this EFT. Even if you are bullish on one or both of them, you are better off buying the individual stocks.

ETF Investment Opinion

IEZ is currently a Sell for me because it does not have enough to offer to make me choose it over any traditional energy index. Even if energy stocks do go up in the next 12–24 months, I think an energy index will easily outperform IEZ.

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