Over the last few months, we become increasingly concerned about companies in the Energy sector, specifically Oil & Gas E&P (Exploration & Production) companies which, in our opinion, have become disconnected from the oil price, which has largely traded in a range even as many of these stocks have been punished. Through August 30, 2019:

For starters, we think there are significant macro sentiment headwinds that are taking their toll. Climate change concerns have continued to send many would-be investors to the sidelines – it seems to us that for a meaningful percentage of the investor universe, oil & gas is now a “no touch” sector. Probably the most notable example: in early March, the $1 trillion Norwegian sovereign wealth fund announced that it would be exiting its oil & gas positions as a way to diversify its asset base – somewhat ironic since this wealth was created by the country’s exploitation of its significant oil and gas resources.

Further, from a supply perspective, these companies are a victim of their own success – the US is now the largest producer of natural gas and oil in the world and can efficiently bring production up to meet any increases in demand very quickly. That means that generally any rise in the oil price will be quickly met with supply. This should effectively cap the oil price and cap their potential profits.

Then, there is the demand side. In the short-run, concerns about oil demand center around the global growth slowdown (especially in places like China that are large energy importers) and a potential recession in Europe. In the long run, the rise of electric vehicles means a future where consumers need gasoline less and less. No matter the time frame, no doubt a challenging outlook.

Finally, over the last several years, the Energy sector has failed to live up to the expected returns that investors anticipated when they jumped in to shore up the industry during the last crisis in 2015/2016. And now, some of these companies are starting to fail at higher rates. According to Fitch Ratings, energy companies with junk-rated bonds are defaulting at a rate of 5.7% as of August, the highest level since 2017. And this financial strain is expected to get worse. S&P tells us that while $9 billion of debt is set to mature during the rest of 2019, $137 billion will be due between 2020 and 2002. For these reasons, fewer investors seem willing to finance this sector on market-like terms (especially as rates in general have continued to decline). We believe this couldresult in higher financing costs going forward and a further negative impact on earnings.

Simply said, in our opinion, it’s highly possible that the entire sector is being “re-rated” at lower multiples for a myriad of reasons and it may be wise to stay on the sidelines for until this market adjustment is fully implemented.

FOR PROFESSIONAL CLIENTS USE ONLY –NOT FOR RETAIL USE OR DISTRIBUTION –CONFIDENTIAL

The views presented herein are those of Validus Growth Investors, LLC (“Validus”) as of September 2019 and are provided for informational purposes only. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend might begin. The information is based on the economic and market conditions as of this date. The information is not intended as a discussion of the merits of a particular offering and should not assume that any discussion or information provided herein serves as the receipt of, or as a substitute for personalized investment advice from Validus or any other investment professional.

This material is provided for informational purposes only and does not constitute a solicitation. The material is not intended to be relied upon as a forecast, research or investment advice and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any forecasts made will come to pass.