Home etftrends.com Evaluating Free Cash Flow Yields in the Energy Sector

Evaluating Free Cash Flow Yields in the Energy Sector

In recent years, the energy sector has focused on improving free cash flow generation, unveiling a compelling investment opportunity.

Historically, energy companies tended to prioritize growth at the expense of free cash flow (FCF). However, a recent shift of focus on productivity and discovering efficiencies means energy companies currently generate substantial free cash flow relative to other sectors.

The energy sector has a higher median free cash flow yield than any of the 11 GICS sectors, according to data from Bloomberg for companies in the S&P 500 as of December 29, 2023. Additionally, the energy sector offers a more generous comprehensive dividend and buyback yield than most of the 11 sectors.

Therefore, it shouldn’t come as a surprise that the VictoryShares Free Cash Flow ETF (VFLO) – an ETF focused on providing exposure to companies with high free cash flow yields – overweights the energy sector compared to the benchmark Russell 1000 Value Index.

The energy sector makes up 24.1% of VFLO by weight as of January 31, 2024. That’s compared to just 7.7% in the Russell 1000 Value.

We believe there are many tailwinds from robust free cash flow generation. Stable free cash flow enables companies to continue to grow dividends and execute buyback programs. These are two attractive sources of potential shareholder returns.

History of Free Cash Flow Yields and the Energy Sector

Energy companies have historically overspent on capital expenditures, causing the sector to generate less FCF than other sectors in the past. In the 2010s, companies were spending a lot of money and were heavily dependent on outside capital to finance growth projects.

In the case of energy, volatile commodity prices mean that free cash flow yields can change relatively quickly. This makes it important to consider a fund that assesses future free cash flow in addition to historical free cash flow yields, like VFLO.

For example, the beginning of 2014 was a high oil price environment. Prices were over $100 per barrel but quickly dropped after Saudi Arabia flooded the market with supply. In response, oil prices dropped to around $40 per barrel.

At the time, energy companies’ financial statements still reflected oil at a higher price point. The free cash flow they generated was based on a figure closer to $80 or $100 instead of $40, based on trailing 12-month measures of free cash flow. However, for funds that consider future free cash flows, investment teams could act accordingly as they knew cash flow yields would eventually fall in response to the declining commodity pricing.

This example underscores the importance of considering future free cash flow. Importantly, future cash flows have the potential to drive returns, not the trailing free cash flow yields.

VFLO’s underlying Index, the Victory U.S. Large Cap Free Cash Flow Index, incorporates trailing and forward-looking FCF metrics into its methodology. Ultimately, selecting companies offering the highest free cash flow while exhibiting above-average growth potential.

VettaFi LLC (“VettaFi”) is the index provider for VFLO, for which it receives an index licensing fee. However, VFLO is not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of VFLO.

For more news, information, and analysis, visit the Free Cash Flow Channel.

Disclosure Information

Carefully consider a fund’s investment objectives, risks, charges, and expenses before investing. To obtain a prospectus or summary prospectus containing this and other important information, visit http://www.vcm.com/prospectus. Read it carefully before investing.

All investing involves risk, including the potential loss of principal. Please note that the fund is a new ETF with a limited history. The Fund has the same risks as the underlying securities traded on the exchange throughout the day. Redemptions are limited, and commissions are often charged on each trade. ETFs may trade at a premium or discount to their net asset value. The Fund invests in securities included in, or representative of securities included in, the Index, regardless of their investment merits. The performance of the Fund may diverge from that of the Index. Investments concentrated in an industry or group of industries may face more risks and exhibit higher volatility than investments that are more broadly diversified over industries or sectors. Derivatives may not work as intended and may result in losses.

Large shareholders, including other funds advised by the Adviser, may own a substantial amount of the Fund’s shares. The actions of large shareholders, including large inflows or outflows, may adversely affect other shareholders, including potentially increasing capital gains. Investments in mid-cap companies typically exhibit higher volatility. The value of your investment is also subject to geopolitical risks such as wars, terrorism, environmental disasters, and public health crises; the risk of technology malfunctions or disruptions; and the responses to such events by governments and/or individual companies.

Additional Information

The information in this article is based on data obtained from recognized services and sources and is believed to be reliable. The securities highlighted, if any, were not intended as individual investment advice.

The Russell 1000® Value Index is a market-capitalization-weighted index that measures the performance of Russell1000® Index companies with lower price-to-book ratios and lower forecasted growth rates.

Capital expenditures (Capex) are funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment

Distributed by Foreside Fund Services, LLC (Foreside). Foreside is not affiliated with Victory Capital Management Inc. (VCM), the Fund’s advisor. Neither Foreside nor VCM are affiliated with VettaFi.


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