BALTIMORE (Stockpickr) -- The energy sector has been a strong performer so far in 2014: For instance, since the calendar flipped to January, the Vanguard Energy ETF VDE has given investors total returns of 10.7%. That's nearly a third more performance than you'd have gotten with the S&P 500 over that same span. And other big energy index funds are posting similar double-digit returns year-to-date too.
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So then, why do hedge funds hate energy stocks right now?
Last quarter, energy wasn't just the only sector that saw net selling among hedge funds -- the "smart money" reduced their holdings in energy by a whopping 12% in the aggregate during the period. That's by far the biggest conviction bet I've seen against a single sector during a quarter.
But while it's interesting to know that funds hate energy stocks, it's a lot more useful to figure out which specific names top off their hate lists this summer. After all, it's the sell list -- the names that institutional investors hate the most -- that represents some of the biggest conviction moves. Scouring fund managers' hate list is valuable for two important reasons: it includes names you should sell too, and it includes names that they're wrong about selling.
Why would you ever buy a name that pro investors hate? It's because, often, when investors get emotionally involved with the names in their portfolios, they do the wrong thing. The big performance gap between hedge funds and the S&P 500 index in the last year and change is proof of that. So that leaves us free to take a more sober look at the names fund managers are capitulating on.
Luckily for us, we can get a glimpse at exactly which stocks top hedge funds' hate lists by looking at 13F statements. Institutional investors with more than $100 million in assets are required to file a 13F, a form that breaks down their stock positions for public consumption. From hedge funds to mutual funds to insurance companies, any professional investors who manage more than that $100 million watermark are required to file a 13F.
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So, without further ado, here's a look at five energy stocks fund managers hate...
Marathon Petroleum
Up first is Marathon Petroleum (MPC), a $25 billion independent refining stock that owns seven refineries across the U.S., with 1.7 million barrels of capacity per day. Marathon is one of the most-sold names from the last quarter, with funds unloading more than 4.38 million shares. At current price levels, that's a $401 million selling operation.
Marathon isn't your typical refining stock. First, around 40% of its refining capacity is located in the Mid-Continent, where it's able to capture discounted crude oil prices and a supply imbalance versus the refinery-rich Gulf Coast. It may seem strange to buy a refiner a time when integrated oil companies have been getting out of the oil business, but MPC has been growing its profitability (net margins hit above 3% last quarter) and building out its midstream operations through the MLP that it spun off in 2012.
That means that Marathon is more integrated than it may first appear. The firm's Speedway business, for instance, sells fuel through almost 1,400 retail gas stations. Those side businesses provide a nice complement to Marathon's core refining business, but ultimately refining is the firm's bread and butter. For investors looking for energy sector exposure (and a nice 2.2% yield), there are worse names out there than MPC.
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Core Laboratories
It's been a rough year for shares of Core Laboratories (CLB) -- the oil service company's stock price has fallen more than 21% since the calendar flipped to January this year. So, it's not completely surprising to see that Core Labs came in high on hedge funds' sell lists this past quarter; CLB fell below their "maximum pain threshold", so fund managers clicked "sell". The relevant question for investors is whether it makes sense to follow suit now.
Core Labs provides oil and gas companies with core and reservoir analysis products and services that help them make better production decisions. That's a pretty easy sell for most of Core Labs' clients: there's a lot of mystery in pulling commodities out of the ground, so the more insight E&P firms can get on their sites, the better. And as oil companies work to pull higher yields out of mature wells, Core Labs' services are even more critical in 2014, a big part of the reason why the firm is able to generate big recurring cash flows each year. Revenues, profits, and margins have stair-stepped higher in each year since the Great Recession, an impressive feat given the shaky trajectory of oil prices.
Despite excellent execution, CLB's share price has looked rough this year. Technically speaking, shares are in a particularly ugly downtrend that's not showing signs of abating. But the deep value price tag on shares means that it makes sense to jump in on the next sign of a sentiment shift -- I'd call a breakout above the 50-day moving average a solid signal to start buying. Even though hedge funds unloaded 1.64 million shares of CLB last quarter, we're getting close to a low-risk opportunity to pick them up on the cheap.
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Valero Energy
Valero Energy (VLO) is another refining name that hedge funds hate right now. The $28 billion firm tips the scales as the largest independent refiner in the country, a fact that painted a big target on its back when pro investors turned on this energy niche. That's why funds sold off more than 7.28 million shares of VLO in the past quarter.
Valero operates 14 refineries in the U.S., Canada, and the U.K., with total network capacity of 2.8 million barrels a day. The firm also has 1.1 billion gallons of ethanol production capacity annually, and, like Marathon Petroleum, it owns a large stake in its own publicly traded pipeline MLP. While Valero has historically been one of the more profitable independent refiners thanks to a very advanced refinery network that's able to process lower-grade crude, margins have been squeezed in recent quarters. And now, investors are putting considerable hope into the possibility of more discounted Gulf Coast crude supplies.
That seems like a shaky value proposition, considering that peers like Marathon are able to double dip from existing discounts in their higher exposure to Mid-Continent refining, and still capture future discounts in the Gulf Coast if they do materialize. Meanwhile, the technicals do at least look promising in VLO right now -- if shares can crack long-term resistance at $58, I'd be a buyer.
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Southwestern Energy Co.
The sole exploration and production play on hedge funds' most-hated list this quarter is Southwestern Energy Co. (SWN), a $14 billion name with oil and gas projects spread across the U.S. and Canada, and natural gas shale wells in Fayetteville and Marcellus here in the U.S. SWN's proved reserves of 7 trillion cubic feet equivalent of gas.
Southwestern Energy is primarily a gas producer, a fact that gives it unique exposure. With natgas priced scraping along lows for years, and the largest integrated supermajors making big bets on gas price increases, SWN's positioning gives it the ability to generate transformational gains if natgas markets turn for the better. The firm's huge proved reserves mean that it has time to wait out the gas market before it ramps up production to collect higher market prices.
Despite the immediate challenges of the natgas market, SWN's extremely low cost of pulling gas out of the ground makes it attractive today. The firm typically collects net margins above 20% for its trouble, putting its profitability on par with E&Ps whose production skews towards oil. And with shares finally catching a big bid last week, SWN could be about to seen an end to selling in August.
All told, funds sold off 8.13 million shares of Southwestern Energy Co. last quarter.
Arch Coal
Last up on hedge funds' energy sector hate list is coal mining company Arch Coal (ACI). It doesn't take a genius to see that ACI has been a huge performance drag for funds in the first half of the year – through the end of July, shares of the $680 million coal producer fell more than 34%. But fund managers who threw in the towel might be calling a bottom here.
Arch operates 32 active mines in the U.S., selling coal to industrial customers like power plants and steel mills. The firm currently has total reserves of 5.5 billion tons of thermal and metallurgical coal at its mines, making it the second-largest coal producer in the country. A transition towards a higher mix of coking coal (most of ACI's coal reserves are thermal, lower priced coal used for power generation) should result in bigger margins and a bigger addressable market as demand in China ramps back up.
The combination of high production costs and a weak coal market have made profitability fleeting at ACI in recent quarters. That said, the price action is already showing signs of a reversal, as coal commodity prices move higher. From a technical standpoint, the move through $3.20 looks like a bottom in ACI, and shares are likely to move higher from here. Arch Coal may be the most speculative name on our list, but it could be the one that hedge funds got the most wrong in 2014.
Last quarter, funds sold off 12.05 million shares of ACI...
To see these stocks in action, check out the Institutional Sells portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.
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At the time of publication, author had no positions in the stocks mentioned.
Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.
Follow Jonas on Twitter @JonasElmerraji
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