Exxon Mobil (XOM) is copping a lot of flak from investors right now. An awful lot of folks out there don’t appreciate the fact that the stock price hasn’t done anything for more than a decade. Indeed, a cursory “side by side” analysis with peer Chevron, which has put on over 50% in capital appreciation in that time, would suggest that Exxon has seriously underperformed. Putting the merits of that statement aside, I’d go out on a limb to say that now is not a bad time for long-term investors to pick up Exxon stock.
Financial numbers year-to-date don’t paint a pretty picture. First, earnings and cash flow are down in what is obviously a tougher macro environment compared to 2018. The company reported earnings of $3.17b in its fiscal third quarter, down a massive 49% on the $6.24b made in 3Q18. For the nine-month period, earnings clocked in at $8.65b versus almost $15b at this point last year. As far as I can see, that relative performance appears the worst out of the “big five” oil majors.
Unsurprisingly, the chief driver of that has been the decrease in oil and natural gas prices. Exxon realized an average liquids price of $54.51/bbl in the United States last quarter. It realized an average price of $64.06/bbl at the same point last year. The company reckons lower liquids prices hit profit by around $1.5b in 3Q19 versus the same point in 2018. Natural gas followed an even steeper downward trajectory, down over 25% in 3Q19 year-on-year.
A couple of other points to note. First, earnings in Exxon’s other operating segments are weaker too. For example, Downstream profit is down around $2b so far in 2019 compared to last year. Its chemicals business is down around $1.5b on the same basis. Second, Exxon has ramped up capital expenditures at the same time as cash flow has weakened. The company spent $7.72b on CapEx in 3Q19, around 17% higher than the $6.59b spent in 3Q18.
The upshot is that free cash flow is being squeezed big time. The company reported free cash flow of around $4.5b over the first nine months of the year, not even enough to cover the dividend. Obviously that is not what we expect to see from Exxon given all the other majors are safely covering their distributions right now.
The good news is that the company isn’t increasing its CapEx for no reason. In its Upstream division, it has five big strategic projects in development: the Permian Basin in Texas; offshore Brazil; offshore Guyana; Mozambique LNG; and Papua New Guinea LNG. The company sees Upstream CapEx coming in at around $48b over 2019 and 2020.
The LNG projects in Mozambique and Papua New Guinea generate decent returns at natural gas prices equal to around $5/MBtu. Likewise, oil production in the Permian, Brazil and Guyana make money at prices well below $50/bbl. At $60/bbl Brent (2017 price, inflation adjusted), the company reckons those projects will help contribute to an incremental $7b in annual profit by 2025.
In addition, Exxon is spending another $17b over 2019/2020 on investments in its Downstream and Chemicals units. Total CapEx spend over the two-year 2019/2020 period is expected to total around $65b – way higher than the current rate of depreciation. In other words, the underlying cash generating ability of the company is not currently reflected in the cash flow numbers. A “steady-state” Exxon, spending enough to keep operations ticking over, would throw off more than enough cash to cover its dividend.
Long-term followers of Exxon will probably be aware that the current 5% dividend yield is historically interesting. In fact, it represents a near twenty-year high as far as I can see. Granted, stock buybacks don’t form part of the shareholder returns equation like they used to, but when Exxon offers up 5% of your investment in hard cash each year, you tend to sit up and take notice.
Given how much profit the company thinks it can throw off at $60/bbl oil, I’d say that makes for an interesting value proposition. Exxon reckons it will generate over $30b worth of annual net profit by 2025 as a result of the investments it is making now. That would put earnings per share at around the $7.15 mark by the middle of next decade based on the current share count. Slap a 15x multiple on that and you end up with a share price north of $105. I would also expect Exxon to pay out a further $25 per share in dividend cash through 2025. For a stock currently trading below $70 a share, that strikes me as a decent deal.
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