Exxon Mobil Corp. (XOM, Financial) is among the few energy companies that did not cut its dividend this year, which came as a surprise to some analysts covering the sector because of the challenges faced by oil companies of every size and scale.
The demand for crude oil fell sharply earlier this year as countries in every corner of the world imposed travel restrictions to help curb the spread of the Covid-19 virus. Manufacturing activities came to a standstill as well, so the demand coming from airlines and cruise line operators fell to near-zero levels. Over the past several months, industry conditions have improved substantially for the energy sector, but there are many uncertainties regarding its outlook as we move into 2021.
Considering many of the challenges the industry is set to face for many more months to come, Exxon Mobil conducted an asset review to determine areas of improvement and the changes that would be required to survive the difficult times. It published its findings and conclusions on Nov. 30. In a statment, CEO Darren Woods said:
"Recent exploration success and reductions in development costs of strategic investments have further enhanced the value of our industry-leading investment portfolio. Continued emphasis on high-grading the asset base - through exploration, divestment, and prioritization of advantaged development opportunities - will improve earnings power and cash generation, and rebuild balance sheet capacity to manage future commodity price cycles while working to maintain a reliable dividend."
In summary, Exxon is prioritizing low-cost exploration bases such as Guyana and the Permian Basin while continuing to focus on reducing operating costs. More importantly, the company is once again confirming its commitment to reward investors through dividends.
The outlook
Macroeconomic factors play a major role in determining the financial performance of the energy sector, and the expectations are improving on the back of positive news regarding vaccines to fight the virus. Many Asian countries, including China, have already begun to return their oil demand to the pre-recession levels, so things could turn out to be similar for the Western world in the coming year if health risks subside as expected. Taking this and the supply cuts imposed by major oil-producing nations into consideration, the U.S. Energy Information Administration projects a barrel of crude oil to trade at an average price of $44.24 in 2021.
Source: U.S. Energy Information Administration
In these expectations materialize in the coming year, they would mark an improvement from the average prices this year and should positively impact the earnings of oil companies.
In the recovery phase of the global economy, low-cost oil producers are likely to come back stronger before small players in the industry that are faced with much higher breakeven oil prices. Exxon Mobil is one of the lowest-cost oil producers in the world. According to research firm Rystad, the company turns a profit at its New Mexico properties if oil prices remain above $27 per barrel. Economies of scale will help Exxon cover its dividends with free cash flow if oil prices remain stable in the coming year as expected by many independent agencies and Wall Street analysts.
A new-look Exxon Mobil is on the cards
According to a report published by The Wall Street Journal on Dec. 6, Engine No. 1 LLC, an investment management company launched by hedge fund veteran Chris James a couple of weeks ago, is preparing to send a formal letter to the management team of Exxon Mobil to request the company focus more on clean energy investments. James is pushing the oil giant to make these radical changes and is seeking to secure four board seats. The guru already has a stake worth approximately $40 million in Exxon Mobil and is believed to have secured the support of California State Teachers' Retirement System, which owns a stake worth more than $300 million.
At the market price of around $42 on Dec. 10, Exxon is valued at a hefty $179 billion, which suggests that the guru is a small shareholder of the company even after combining his stake with that of the aforementioned pension fund. However, there have been instances in which minority shareholders have been successful in activist campaigns. If the hedge fund guru is able to convince Exxon to pursue growth opportunities in the clean energy sector, it will be a big win for long-term shareholders.
Correspondents from The Wall Street Journal have already seen the letter that will be sent to the company, and Engine No. 1 claims Exxon will make an irrevocable mistake if it fails to prioritize investing in sustainable energy solutions. In its letter, the firm noted, "We believe that for Exxon Mobil to avoid the fate of other once-iconic American companies, it must better position itself for long-term, sustainable value creation."
Engine No. 1 is not the only activist shareholder that is pressuring Exxon. D.E. Co. & Shaw has also built a sizeable position and sent a letter to the company on Dec. 9 requesting cost reductions to save the dividend. Commenting on this development, RBC Capital Markets analyst Biraj Borkhataria wrote:
"Exxon is in the early stages of the cost reduction story. To the extent that D.E. Shaw can accelerate this process, I would say it's positive and should be helpful to shareholders."
If Exxon decides to tweak its business model to prioritize clean energy solutions, investors will be rewarded in two primary ways. First, such a decision will help the company report stellar growth in its earnings once again as this industry is young and provides high-growth opportunities. Second, the market is likely to assign Exxon Mobil stock a higher earnings multiple in approval of the positive changes. Many investors are doubtful of the future of oil companies because of the expected regulatory changes that would limit the usage of crude oil. The best way to alleviate these concerns and to attract high valuation multiples is to focus more on renewable energy sources, which is exactly what the activist investor wants from Exxon.
The success of this campaign, however, will ultimately rest on the top shareholders of the company. The list, as shown below, is dominated by investment management companies.
The next couple of months might bring radical changes to the business model of Exxon Mobil, and these changes are likely to be welcomed by investors.
Takeaway
Crude oil is the cheapest and most widely available energy source in the world today. Even though many countries are promoting the use of green energy solutions, crude oil is likely to remain the world's leading energy source for the foreseeable future. However, growth prospects for oil giants will be limited because regulators are reluctant to approve billion-dollar investments in exploration sites.
The industry, therefore, will exhibit signs of maturity in the coming years and consolidation among large players is likely. Exxon Mobil, the largest oil producer in the United States, is well positioned from a liquidity perspective to overcome the near-term challenges and deliver acceptable returns to income-oriented investors. The company recently reaffirmed its stance on dividends, and a couple of activist investors are pressuring the company to reduce capital expenditures in order to maintain the dividend at its current rate. These developments make Exxon Mobil a very good candidate for inclusion in any income investor's portfolio.
Disclosure: The author does not own any stocks mentioned in this article.
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