* Shares in oil majors left out of Europe's two-year rally
* Sector trades at a record price-to-book discount
* Sector may be past low point of investor pessimism -HSBC
* Trimmed capex, stronger cash flows, payouts to spur
* Sector offers 4.5 pct dividend yield vs market's 3.2 pct
By Blaise Robinson and Atul Prakash
PARIS/LONDON, Jan 24 Europe's energy stocks,
shunned by investors for two years because of jitters over
dividends and oil prices, are poised for a revival as companies
start to cut investments and generate more cash.
The sector - trading at a record discount to the broad
market even though it offers hefty payouts - is also set to
benefit from rising prospects of an acceleration in global
growth, which should support oil prices and boost profits.
That has prompted a growing number of asset managers, such
as ING IM and Societe Generale Private Banking, to highlight
energy stocks among their top picks for this year.
Shares of oil majors Royal Dutch Shell, BP,
Total and ENI have barely budged in the past
two years, falling behind a 36 percent surge in the broad MSCI
Europe index due to worries over costly projects
that have eaten into cash flows and threatened dividends.
In recent months, however, investors have been putting
pressure on the oil firms to return more cash to shareholders
and several major companies have started to respond positively,
setting the scene for a rebound in the shares.
"Capital expenditure is going to start to tail off and as a
result, you'll see a pick-up in the free cash flow. That's
positive for potential returns to shareholders," HSBC equity
strategist Robert Parkes said.
"You need a catalyst and we've got one in terms of improving
cash profiles. Energy remains deeply out of favour among large
international funds, but we are now starting to see some buying
interest. This suggests that we may well be past the low point
in terms of investor pessimism on the sector."
BP's shares have risen 9 percent since it raised its
dividend, cut capital spending plans and ramped up its asset
sales target in late October.
In a similar tone, France's Total boosted expectations of
higher payouts after announcing a "soft landing" in capital
expenditure to cut costs and generate greater cash flow. Its
stock is up 8 percent since mid-December.
Shell, which has been seen as the least responsive to these
shareholder demands, also seems to be listening and has promised
that spending will be lower in future years.
"Capex was too ambitious in the oil patch lately, but
companies are getting much more disciplined now," said Nicolas
Simar, fund manager and head of the equity value team at ING IM,
which manages 176 billion euros ($238 billion).
"The sector's discount to the broad market is set to
disappear," said Simar, whose ING Euro High Dividend portfolio
is 'overweight' energy stocks.
Chart on valuation ratios: link.reuters.com/tav26v
Chart on dividend yields: link.reuters.com/hed36v
Investors have shunned the sector so much in the past two
years that it trades at a record discount to the market in terms
of price-to-book and is the cheapest in a decade on
price-to-earnings, offering a rare spot of value among European
"When you look at their relative valuation levels versus the
broad market, the oil sector trades at a near 10-year low," said
Claudia Panseri, head of Societe Generale Private Banking, with
84 billion euros ($114 billion) in assets under management.
"The cheap valuation ratios in the sector, as well as
attractive dividends which now look safer, should fuel a
rebound. We're buyers of the energy sector," said Panseri, who
has the oil and gas sector on her 'conviction list' for 2014.
The MSCI Europe energy index trades at 10.2
times expected earnings in the next 12 months, well below its
20-year average of 13.1 times, and representing a 25 percent
discount to the broad MSCI Europe index.
The beaten-down sector looks even cheaper when looking at
price-to-book ratios. It trades at 1.33 times book value,
sharply below a 20-year average of 2.38 and still near a low of
1.17 hit last July, the lowest price-to-book ratio recorded
since MSCI started to track the sector in 1995.
Relative to the broad market, the energy sector trades at a
record discount of 27 percent in terms of price-to-book.
Even when looking at cash flows - which has been a sore
point for the sector - energy stocks trade at 5.3 times cash
flows expected in the next 12 months, among the lowest ratios
for European sectors, according to Thomson Reuters Starmine.
With improving cash flows, fund managers said worries over
the sustainability of payout ratios are fading, and yield
hunters will soon rush into energy shares again.
The sector offers a lofty dividend yield of 4.5 percent,
well above the broad market's 3.2 percent and about 240 basis
points above German 10-year Bund yields.
"Earnings look set to improve, valuations and dividends are
attractive and many companies are in good financial health,"
said James Butterfill, global equity strategist at Coutts, who
is bullish on the sector.
(Editing by Catherine Evans)