Breaking Down the Energy Select Sector SPDR ETF

ETFs are often portrayed as a simple way to invest in the stock market. But determining the potential of individual ETFs isn't so simple. Many ETFs that cover the same sector often hold different securities in varying percentages, which can produce drastically different end results. For this reason it is wise to take a closer look at the components and weighting in order to determine investment potential. Here we will be dissecting the largest and most popular energy ETF, the Energy Select Sector SPDR ETF (NYSEMKT: XLE  ) .

The Energy Select Sector SPDR ETF is composed of 44 different securities. The top three securities in terms of percentage weighting are ExxonMobil at 15.84%, Chevron at 12.87%, and Schlumberger at 7.42%.

All three of these were discussed at length in previous articles, so here is a brief summary of the findings: ExxonMobil appeared overvalued compared to industry averages while expecting flat EPS growth for two years. Chevron was more fairly valued but suffered from the same stagnant EPS growth projections. But Schlumberger looked to be poised for solid EPS growth while being fairly valued and an industry leader in many key metrics.

Based on these findings, the top three stocks for the Energy Select Sector SPDR ETF present a bit of a conundrum. Aggressive investors might look at it as doomed to underperform with ExxonMobil and Chevron composing 28.71% of the fund. On the other hand the safety of a mega-cap oil company is something more risk-averse investors can appreciate. The addition of Schlumberger brings back the strong prospect for growth, which lends some balance between safety and growth. But perhaps we need to look even deeper at this point and see what else is in this fund.

Coming in at the number four spot with a 3.69% index weighting is EOG Resources (NYSE: EOG  ) . This company is poised to take advantage of the energy revolution currently underway in North America with a presence in the Marcellus Shale, Barnett Shale, Permian Basin, and the Eagle Ford shale, where it is the second largest rig operator (behind BHP Billiton). In fact, 94% of its proven reserves are in the United States.

EOG's stock is up 57% over the last 52 weeks but still looks fairly valued in terms of the industry average P/E with EOG sporting a 24.30 P/E vs. 23.50, respectively. Analysts are looking for strong growth, projecting a 20.97% EPS increase in FY 2014. If you believe in the future of U.S. energy this is one solid way to play the sector.

Further down is Occidental Petroleum (NYSE: OXY  ) , which composes 3.63% of the fund. Last year saw dramatic improvements in a couple key areas that should pave the way to increased profitability going forward. Capital efficiency was improved by 24% and oil and gas operating expenses were down 17%.

These positive developments were responsible for $1.4 billion in savings during 2013 compared to 2012. This success has prompted Occidental to increase its capex for 2014 by well over 10%. Stephen I. Chazen, president and CEO, commented, "Our comfort in raising our capital expenditures is a direct result of the improvements in our efficiency and margins due to the success we achieved in our cost-reduction efforts."

This strategy that Occidental is embarking upon is a popular one that has proven its worth over the long term. Addressing efficiency and operating expenses before deploying increased capex should result in a greater return on capital employed going forward. This should improve earnings and increase shareholder value.

Analysts appear divided on Occidental's future with high and low estimates varying significantly. The result is a tepid outlook if the consensus is to be believed. But given the improvements in 2013 and management's commitment to increasing shareholder value, bullish analysts predicting 10% EPS growth in 2014 and 15% in 2015 are probably not too far off.

Final thoughts
The Energy Select Sector SPDR appears to be a mixed bag, which could be a good thing. Composing just over one-quarter of this ETF are mega-caps that promise safety and reliability. The next tier down looks to be poised for significantly better EPS growth. This makes for a great combination of security and potential. So, if you're looking for that middle ground then the Energy Select Sector SPDR could be your ticket to decent returns and a good night's sleep.

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