I have held back on talking about Exxon Mobil (XOM) stock during this crisis. This isn’t because I take a negative view on its investment prospects, although I appreciate that may sound crazy in the current environment. Having been optimistic when it traded at $70 a share, it stands to reason I think it is a long-term steal right now at around the $42 per share mark. I figured that much was clear having covered the stock a number of times in the last few months.
Anyway, something stood out to me after browsing one of the latest Exxon Mobil pieces over on Seeking Alpha. I’m paraphrasing here, but one commentator declared that the energy patch was a no-go zone for investors for at least the next two years. I read that comment as meaning that folks should wait for higher energy prices and corporate earnings before returning.
In my view, this is definitely not the way to view the current crisis. In fact, the only way that statement makes sense to me is if things were to actually get progressively worse, culminating in a bottom two years from now. Herein lies one of the most important parts of investing in cyclical industries: the best times to invest often coincide with the most horrific operating conditions. That’s just the way it is.
Take a look at the Saudi’s buying a $775m stake in cruise line operator Carnival Corporation. Do you think they are buying expecting blowout earnings in 2020? No, clearly not. They are buying because profits a few years from might give that stake a massive yield on cost. Granted, it’s not the energy patch, but the same principle applies.
In the past, not many long-term Exxon shareholders would have worried about all this. I mean, it has generated somewhere in the region of $287,000m in retained profit over the past fifteen years. Who cares if it made more in some of those years, and less in others? The dividend distributions were ultimately covered with a boat load of change left over. So what if it had to smooth out some payments in the bad times?
Most readers know all of this, but I mention the above since its dividend is now under pressure to a greater extent than at any point in recent history. All parts of its business face awful operating conditions. Oil prices have crashed, including a bizarre foray into negative territory recently. Refining and chemical margins are also on the floor as demand for end products has cratered.
The fact that Exxon’s dividend now yields north of 8% tells you as much. The key issue is that it costs the company somewhere in the region of $15,000m annually to pay it, while this year’s capital spending level amounts to around $23,000m. Put another way, Exxon must generate $38,000m in cash from its operating activities in order to hit breakeven this year.
Needless to say, that isn’t going to happen. It generated $29,700m last year on the back of an average crude oil price in the $60 per barrel region. On that basis, the company might need to make up a shortfall of over $20,000m this year. That means we are looking at somewhere in the region of $65,000m in net debt heading into next year, with its gearing ratio approaching 30%. I think Exxon can carry that, but let’s see how bad things get. It has already raised an extra $18,000m thus far at cheap interest rates.
In any case, none of the above changes my view on the stock at $42 per share (or lower, should it go that way). I think it is a steal provided your outlook extends beyond the next year or so. Anyway, most readers know that I base my outlook on an average oil price in the $60 per barrel area. On that basis, Exxon had 2025 net profit coming in at around $25,000m. That amounts to retained earnings in the $10,000m per annum region based on its current dividend, enough to take care of debt and possible share repurchases.
Think about that for a moment with respect to the current share price. First and foremost, it means you would receive the vast majority of your capital outlay back within a decade by way of cash dividends. If it commands a valuation multiple of 12x earnings, then we are back at a share price of around $70 or so. The associated dividend yield would be in the 5% region. Granted, all this looks fanciful given the current carnage. But that’s the deal with cyclical industries. Waiting for commodity prices and earnings to recover just won’t work unless stock prices remain in the toilet.
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