Why Warren Buffett Swapped ConocoPhillips for Exxon
Buffett is famous for saying, “It is better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price.” He adopted this philosophy after spending the early part of his career as more of a bargain hunter and finding it less profitable. An important indicator of a “wonderful business” for Buffett is the return on equity (ROE).
Over the last several years, ConocoPhillips and Exxon Mobil (NYSE:XOM) have demonstrated very different ROE capability. Conoco’s five-year history of ROE is both lower and slower growing. It was ranging from 7.1% in 2009 to 17.6% in 2012, as seen in the graph below:
Exxon, by contrast, since 2009 has yielded ROE ranging from 17.4% in 2009 to 27.1% in 2012, with an increase each year, per the chart below:
In fact, the company has the highest return on equity of any U.S. companies in the integrated oil and gas industry.
Since ROE measures the company’s ability to generate earnings growth on investment funds, the return on equity is often a reflection of management. This will become increasingly important in upcoming years as experts predict that locating and extracting oil will become more costly. In March, Exxon announced it would be raising its capital expenditures guidance for the next several years to a record $38 billion annually, from its previous guidance of $37 billion at year-end 2012. This was an increase from the $36.8 billion it spent in 2011.
The outsized spending phenomenon is not unique to Exxon. Both Chevron Corp. (NYSE:CVX) and Royal Dutch Shell Plc (RDS) have increased their capex budgets this year. This means that a large part of whether oil and gas companies earn solid returns on their investments will increasingly come down to the deftness of management.
"Due to its financial strength, debt capacity and diverse portfolio of opportunities," Exxon said in its 2012 10-K, "the risk associated with failure or delay of any single project would not have a significant impact on the corporation's liquidity or ability to generate sufficient cash flows for operations and its fixed commitments."
Exxon is currently led by Rex W. Tillerson, its chairman and chief executive officer. Tillerson joined Exxon in 1975 and was formerly its general manager of Exxon Company U.S.A.’s central production division, production advisor, president of Exxon Yemen Inc. and Esso Exploration and Production Khorat Inc., vice president or ExxonMobil Development Company, among other roles. He became CEO on Jan. 1, 2006.
In Tillerson’s shareholder letters, he emphasizes competitive advantages – another point Buffett checks for in his investments. Tillerson lists Exxon’s as: a balanced portfolio, disciplined investing, high-impact technologies, operational excellence and global integration, which allows it to operate more efficiently.
He is also committed to shareholders and making only high-quality investments. As he told Charlie Rose on March 7: “My philosophy is to make money. If I can drill and make money, then that’s what I want to do. For us, it’s about making quality investments for our shareholders. And it’s not a quality investment if you can’t manage the risk around it.”
Buffett also appreciates a company with good potential for significant future growth, though Exxon in this case is the slower grower. Growth in global energy demand is expected to increase by 35% between 2010 and 2040, according to Exxon. The company forecasts that its production will decline by 1% in 2013 on weaker natural gas, then increase by 2% to 3% annually, or 14% overall, through 2017, as its new projects ramp up.
Last year, Exxon’s production fell by 6%. The company CEO Rex Tillerson said the decline was caused by operational performance issues, lower prices and lower spending in Iraq.
ConocoPhillips has slightly higher aims for itself, predicting 3% to 5% compound annual production growth over the long term, funded in large part by assets sales. In total, it expects 25% production growth by 2017. It also in December 2012 announced it would keep its capex budget for 2013 flat from the previous year at $15.8 billion.
Lastly, Exxon Mobil has historically shown greater predictability than ConocPhillips. GuruFocus gives Exxon 2.5 stars, and ConocoPhillips one star in the category. Predictability rankings are based on the consistency of revenue per share and EBITDA per share over the previous 10-year period, and their correlation to a company’s stock performance.
The below charts illustrate the contrast between the revenue and EBITDA histories of Exxon and ConocoPhillips:
For more Buffett stocks, visit his portfolio here. Also check out the Undervalued Stocks, Top Growth Companies, and High Yield stocks of Warren Buffett.
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