Exxon Mobil (XOM) surely wins the prize for most unloved mega-cap right now. Market sentiment is horrid, and for good reason too. The price of oil remains way down on its pre-pandemic level, while conditions downstream are bad too. All of that at a time when Exxon wanted to ramp up capital spending too. As a consequence, cash flow has been seriously squeezed and its sacrosanct dividend arguably faces greater scrutiny than at any time in the past few decades.
In terms of the numbers, recently released financials covering 1H20 lay bare the issue. The company only generated around $6,300m in cash from operating activities over the first six months of the year, while the combined dividend and capital spending bill clocked in at around the $20,000m mark over the same period. Suffice to say, that is a big outflow gap. Net debt levels have risen accordingly.
To be clear, there is nothing inherently wrong with an ill-covered dividend right now. The company could only realize a crude oil price of $21.80 per barrel in the second quarter because of the COVID-19 demand shock. That is way down on where it will average in the years ahead. So long as the firm throws off enough retained earnings in better years, smoothing out lean periods is fine. Indeed, that is the nature of the beast in cyclical industries. In exchange you get a higher than average yield to wait out the storm. Reinvesting those chunkier yields is historically what produced the oil majors’ palatable long-term returns.
With that in mind, I understand management’s determination to preserve the dividend at all cost. It will reduce annualized capital spending to the $19,000m range by the end of the year, as well as strip out a bunch of operating costs. Is that enough to avoid a cut? I’m not all together sure given management’s comment about no more debt. The cash flow statement will surely need to see higher oil prices to support that statement.
In terms of the numbers, Exxon had roughly $12,500m in cash on its balance sheet at the end of the quarter. Cash outflow over the rest of the year should register around the $19,000m mark. On the inflow side of the equation, conditions have clearly improved versus last quarter, though the numbers remain tight. The company would still deplete most of its current cash pile even if it generated north of $10,000m in cash from operations.
The main issue is that the company entered the year with nearly $44,000m in net debt. That figure now stands at around $57,000m. Some quick number crunching would suggest it will swell over the $65,000m mark by the end of the year. If that moves higher, analysts see a risk of permanently higher leverage, even when the company returns to generating billions in post-dividend retained profit.
Personally, I’m not sure that Exxon is at that point just yet. Despite the rapid increase of debt, the gearing level here remains under the 30% mark. That’s before mentioning the firm’s strategic investments – Guyana and so on, which have been covered here previously. Although debt has increased substantially here in recent years, so too have assets. This will translate into double-digit billions of dollars in terms of annual retained profit generation, even under relatively benign operating conditions.
In any case, the dividend speculation does not really alter the investment case right now. The stock remains very cheap in my view. At some point, operating conditions in the sector will improve and the company will be on track to make a bunch of money once again. Tens upon tens of billions of dollars have left the space in terms of capital investment. Global capital spending is at the lowest level in fifteen years. That will translate into higher oil prices down the line once demand – and demand growth – normalizes. I doubt the stock will offer up an 8% dividend yield when the underlying business returns to $5 per share in net profit generation. On that basis, we could easily see 100% returns from here over the next five years or so.
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