Scott Burns: M&A is heating up in the oil and gas patch, and we've got the ETF to capitalize on that. Hi there. I'm Scott Burns, Director of ETF Analysis with Morningstar.
Exxon's announcement recently to purchase XTO Energy at a mind-boggling 25 percent premium has really got people thinking about how the entire natural gas complex in the United States is going to work out, and a certain move by the majors to move into that area. When we look at the oil majors, the Exxons, the Chevrons of the world, we see that they're actually natural gas light, especially when we look at alternative forms of natural gas or non-conventional natural gas, as it's called.
Working with our equity analysts here, they've identified actually eight very likely targets in the oil and gas patch. When we cross-reference that list and dig deep into ETF portfolios, there's one ETF that really jumps out, and that's iShares Dow Jones Oil & Gas Exploration Index. The ticker on that is IEO.
This is a fund that actually we've been big fans of in the Morningstar ETF Research Group. It's actually the third largest holding in our ETFInvestor, hands-on, tactical portfolio. When we look at that fund, it was actually also the third largest holder of XTO Energy. So it was a big day for that fund and for that stock.Read Full Transcript
When we take a look at the names that are most likely to be targets and then cross that to the IEO portfolio, we see names like Anadarko, which is the third largest holding in IEO and takes up seven percent of the assets currently, and Chesapeake energy, which is a top ten holding. It makes up four percent in assets. A little further down the list, Devon Energy, which is a top five holding, makes up 6.6 percent of the assets. When we go a little further down in one of the larger mid-caps, we find Southwestern Energy, and that makes up about four percent of the portfolio.
So all told, just in the large-cap names that our equity analysts have identified as very likely targets for the oil majors, that makes up 22 percent of IEO's portfolio. So 22 percent of this fund is a high likely M&A activity list.
Now, our equity analysts, headed by Associate Director of the Energy Team, Eric Chenoweth, have also identified some small- and mid-cap names, and we won't go through those names. When we add that up, that actually boosts the number of readily identifiable attractive M&A assets out there up to 28.8 percent of IEO's portfolio, which is really an astounding number when you think about it. It is rare to find an ETF that so thoroughly has segmented the market to capitalize on such a dominant theme.
Now, the one thing when we look at M&A is that premiums rarely go down. They only go up, and an old joke in the M&A world is that the most expensive deal is always the last deal done before the bubble. So that 25 percent premium on XTO is something that we think investors can really expect to go up over time.
So even though IEO has had a great run -- I believe it's up six or seven percent over the past four or five days -- we think it's still got a lot of legs to it as these oil majors, a) look to keep up with Exxon, and from all reports, what Exxon looks like they're doing is building a platform with which to really start to gather these assets and move into this non-conventional natural gas space.
One thing we'd say is to actually steer clear of some of the more broad market energy ETFs, things like the Energy Select SPDR, ticker symbol XLE. Thirty-five to forty percent of that portfolio is in Exxon or Chevron, and generally when M&A is going on, the buyers are the ones who have the stock prices suffer. The targets are really where you want to be. So if you're looking for a readily identifiable M&A to try to capitalize on, look no further than iShares Dow Jones US Oil & Gas Exploration Index.
For any of your ETF concerns, check out the ETF tab on Morningstar.com and Morningstar's "ETF Investor Newsletter." Thanks. I'm Scott Burns.